Chapter 5 - MBA ECON
Long-run average cost curve
A curve that defines the minimum average cost of producing alternative levels of output allowing for optimal selection of both fixed and variable factors of production
Irrelevance of Sunk Costs
A decision maker should ignore sunk costs to maximize profits or minimize loses
average product
total product divided by the quantity used of the input
Profit-Maximization input usage
-To maximize profits, use input levels at which marginal benefit equals marginal cost -When the cost of each additional unit of labor is w, the manager should continue to employ labor up to the point where VMPL = w in the range of diminishing marginal product.
Fixed costs
Cost that does not change with output
Sunk cost
Cost that is forever lost after it has been paid
Economies of scale
Declining portion of the long-run average cost curve as output increase.
Cost complementarity
Exist when the marginal cost of producing one type of output decreases when the output of another good is increased
Economies of scope
Exist when the total cost of producing Q1 and Q2 together is less than the total cost of producing each of the type of output separately
The Leontief production function implies
L-shaped isoquants.
The production function
Mathematical function that defines the maximum amount of output that can be produced with a given set of inputs. Q= F(K,L)
The Cost Function
Mathematical relationship that relates cost to the cost-minimizing output associated with an isoquant
Constant returns to scale
Portion of the long-run average cost curve that remains constant as output increases
Cost-minimizing input rule
Produce at a given level of output where the marginal product per dollar spent is equal for all inputs; a firm should employ inputs such that the marginal rate of technical substitution equals the ratio of input prices
Cost minimization
Producing at the lowest possible cost.
Diseconomies of scale
Rising portion of the long-run average cost curve as output increases
law of diminishing returns
The marginal product of an additional unit of output will at some point be lower than the marginal product of the previous unit
Marginal rate of technical substitutions (MRTS)
The rate at which a producer can substitute between two inputs and maintain the same level of output.
Optimal Input Substitution
To minimize the cost of producing a given level of output, the firm should use less of an input and more of other inputs when that input's price rises
Measures of productivity
Total Product Average Product Marginal Product
Which curve(s) does the marginal cost curve intersect at the (their) minimum point?
average total cost curve and average variable cost curve
What is implied when the total cost of producing Q1 and Q2 together is less than the total cost of producing Q1 and Q2 separately?
economies of scope
It is profitable to hire units of labor as long as the value of marginal product
exceeds wage.
in the short run, some of production factors are
fixed
in the production function K is
is the quantity of capital input
The change in total output attributable to the last unit of an input is the
marginal product.
The absolute value of the slope of the isoquant is the
marginal rate of technical substitution.
Variable factors of production are the inputs that a manager
may adjust in order to alter production.
negative marginal product
means that the last unit of the input reduced the total product (too many workers to be efficient)
If the last unit of input increases total product, we know that the marginal product is
positive.
The Role of the Manager in the Production Process is to
produce output on the production function; Aligning incentives to induce maximum worker effort. Use the right mix of inputs to maximize profits; To maximize profits when labor or capital vary in the short run, the manager will hire labor until VMPl = wage rate and capital until VMPk = rental rate
average product of capital is
quantity divided by capital
average product of labor
quantity divided by labor
Changes in the price of an input cause
slope changes in the isocost line.
Costs that are forever lost after they have been paid are
sunk costs.
Isocost lines
the Combination of inputs that yield the same cost. For given input prices, isocosts farther from the origin are associated with higher costs. Changes in input prices change the slopes of isocost lines
marginal product
the change in total output attributable to the last unit of an input marginal product of capital = change in total output/change in capital marginal product of = change in total output/ by change in labor
'long run' is
the horizon over which the manager can adjust all factors of production
in the production function Q is
the level of output
total product
the maximum quantity of output that can be produced with the given combination of inputs
in the production function L is
the quantity of labor input
'short run' is
the time frame in which there are fixed factors of production
inputs that can be adjusted in the short run are
variable factors of production