Econ Quiz 2
Production Process decisions are based off
- the price of input - techniques of production available
production technology
- the quantitative relationship between inputs and outputs - lowest cost technology is the best technology
Long tern firms by looking at short term circumstances
1. firms that earn economic profits 2. firms that suffer economic losses but continue to operate to reduce or minimize those losses 3. firms that decide to shut down and bear losses to equal to fixed costs
Choices of Technology
2 things determine the cost of production: 1. technologies that are available 2. input prices
Production Function/Total Production function
A numerical or mathematical expression of a relationship between inputs and outputs. It shows units of total product as a function of units of inputs.
firm
An organization that comes into existence when a person or a group of people decides to produce a good or service to meet a previeced demand **under perfect conditions, firms are profit maximizing
The Behavior of Profit-Maximizing Firms
Decisions a firm must exhibit in order to qualify as "profit maximizing" 1. How much output to supply 2. Which production technology to use 3. How much of each input to demand
Costs in the SHORT RUN
Fixed Costs Variable Costs Total Costs
total cost
Fixed Costs + Variable Costs
Types of technology
Labor Intensive, Capital Intensive
total, average and marginal product
Marginal and average product curves can be derived from total product curves. Average product is at its maximum at the point of intersection with marginal product. Diminishing Returns kick in when MP begins to fall
a firm operates at
P* = MR = MC
long-term equilibrium
SRMC = SRAC = LRAC - firms make no profits so that P=SRMC=SRAC=LRAC
SRAC
Short run average cost
Average Fixed costs
TFC/Q or ATC - AVC as output increases, AFC declines b/c we are dividing a fixed number by an increasingly larger quantity
Capital Intensive Technology
Technology that relies heavily on capital instead of human labor - usually cost minimizing in places with higher wages
Marginal Cost (MC)
The additional cost incurred from the consumption of the next unit of a good or service **MC measures additional cost of inputs required to produce each successive unit of output T he easiest way to derive MC is to look at the TVC and subtract. as a firm increases input, the demand for inputs increases
shut down point
The point where the price of a good or service is equal to the minimum point on the average variable cost curve. PROFIT = 0
spreading overhead
The process of dividing total fixed costs by more units of output. Average fixed cost declines as quantity rises.
Average Product of Labor
Total Product/Total Units of Labor If marginal product is above average product, the average rises If marginal product is below average product, the average falls
Operating Profit/Loss
Total revenue - Total variable cost ***if a firm has a certain amount of fixed costs it will sustain. And if the firm can offset some fixed costs by making a short term profit, they will Even if (TFC+TVC)>TR (they are making a loss)
variable costs
a cost that depends on the level of production chosen any input that mist be purchased to increase short run production
Intuition
a firm eventually gets less and less new production out of each new input
U-shaped long run average cost curve
a firm exhibiting diseconomies of scale
The bases of decisions
a firm needs to know; 1. The market price of output (determines potential revenues) 2. The techniques of production that are available 3. The prices of inputs
long-run average cost curve
a graph that shows the different scales on which a firm can choose to operate in the long run we want the lowest cost per unit - each scale of operation defines a different short run LRAC
total variable cost curve
a graph that shows the relationship between total variable cost and the level of a firm's output TVC is deprived from production requirements and input prices TVC curve embodies information about both input prices and technologies, it shows the cost of production at each output level given certain input prices
increasing returns to scale (economies of scale)
an increase in a firm's scale of production leads to lower costs per unit produced Long-run average cost is falling LRAC if a firm doubles all inputs, outputs will be more than double ex) technologies
constant returns to scale
an increase in a firms scale of production has no effect on costs per unit produced LRAC is flat if a firm doubles all inputs, outputs double exactly
decreasing returns to scale (diseconomies of scale)
an increase in a firms scale of production leads to higher costs per unit produced LRAD is rising if a firm doubles all inputs, output is less than double
perfect competition
an industry in which; - there are many firms, each small and relative to the industry - each firm produces identical/homogenous products and in which no firm is large enough to have control over any prices - new competitors can freely enter and exit the market
fixed costs (sunk costs)
any cost that is not dependent on the firms level of output incurred even if the firm is not producing anything there are NO fixed costs in the long run firms have no control over fixed costs in the short run AFC x q
if P<AVC
any time the price is below the minimum point on the AVC curve, and the operating profit will be negative at any output level. the firm should shut down in the short run the minimum point of the AVC curve is called the shut-down point
Positive Economic Profit
appears when MC is larger than Average total costs (ATC) Look to see where price is intersecting the marginal cost curve, if it is above the MC curve it is positive profit P=TR-TC
Capital and Labor
are complementary inputs
a fixed factor implies
diminishing returns and limited capacity to produce as the limits are produced the marginal costs rise Declining marginal product = downward trend in slope of MP curve Rising Marginal Costs = upward trend in slope total variable costs always increase with output
if a firm is profit maximizing, a competitive firm(s) will... (Long term)
enter the industry increase supply drive down prices for the industry as a whole in a perfectly competitive firm there are very little barriers to entry
if TR>TVC
excess revenue can be used to offset fixed costs and reduce losses it will pay the firm to keep operating in the short-run
How to see if profit is maximized
higher value under profit column (TR-TC) another way to see MR is to see where MR is >/= MC and producing up the the point until MR=MC
Marginal cost (short run)
in the short run every firm is constrained by some fixed inputs that; a. lead to diminishing returns to variable inputs b. limits its capacity to produce as a firm approaches that capacity, it becomes increasingly costly to produce successively higher levels of input marginal costs ultimately increase with output in the short run in the short run we are discussing fixed-production scales
zero economic profit
indicated by P*= ATC
Profit maximizing level of output
marginal revenue and marginal cost are exactly equal added output means added profit firms will produce an additional unit of output as long as they will get more money from selling it than it cost them to make it
Long-Run any price below P*
means that firms are suffering losses, and firms will exit the industry
Profit maximizing firms will choose the technology that...
minimizes the cost of production given the current market prices will use the lower cost technology over the more expensive/advanced technology
Short-run profits
moves in and out of equilibrium
a profit-maximizing perfectly competitive firm will...
produce up to the point where the price of its output is just equal to short run marginal cost the live of output at which P* (market price)=MR=MC this is the profit maximizing level for all firms where MR=MC **each additional unit increases revenues by more than it costs to product the additional output because P>MC **at any market price, the marginal cost curve shows the output level that maximizes profit
SRMC
short run marginal cost
marginal cost curve
shows total variable cost changes with single-unit increases in total output
Inputs can also be
substituted for one another - if labor becomes too expensive, firms can replace labor with capital
Labor Intensive Technology
technology that relies heavily on human labor instead of capital - usually cost minimizing technology in rural areas and developing countries
Declining Marginal product implies
that marginal cost will eventually rise with output
Marginal Revenue
the additional income from selling one more unit of a good; sometimes equal to price in perfect competition P=MR in a perfect market, the demand curve and marginal revenue curve are identical in a perfectly competitive market they will sell a homogenous product for anything more than Eq. price so MR will also be equal to equilibrium price
marginal product
the additional output that can be produced by adding one more unit of specific input, ceteris paribus
Average Product
the average amount produced by each unit of a variable factor or production
marginal costs
the cost of producing one more unit of a good
if TR<TVC
the firm operating will suffer losses in excess of fixed costs In this case, the firm can maximize its losses by shutting down in the short-run
in the long run if P>AVC
the firm should consider a future permanent shut down b/c total costs are still greater than TR when the firm suffers losses
if market price is intersecting the marginal cost curve anywhere above ATC...
the firm should continue to operate and has positive economic profit
if market price is intersecting the marginal cost curve below ATC and above AVC...
the firm should continue to operate but will continue to incur losses
As long as P>AVC
the firm will gain by operating in the short run rather than shutting down the firm should continue to operate in the short run even if it is suffering losses
is the market price intersects the marginal cost curve at or below AVC...
the firm will shut down and not be able to offset some fixed costs.
average fixed costs
the fixed cost per unit produced
Long Term Decision
the period of time for which; - there are no fixed factors of production, firms can increase or decrease the sales of operation. - new firms can enter and existing firms can exit the industry
short-run decision
the period of time in which; - the firms is operating under a fixed scale of production ( this fixed short run factor is normally capital) - firms can neither enter nor exit the industry
Production
the process by which inputs are combined, transformed, and turned into outputs
optimal method of production
the production method that minimizes cost for a given level of output
Hiring additional labor increases
the productivity of capital - When more workers are hired at a plant that is operating at 50% capacity, previously idle machines become more productive
Additional Capital increases
the productivity of labor - The amount of output produced per worker per hour
optimal scale of plant
the scale of plant that minimizes long-run average cost lowest point on LRAC curve
Breaking Even
the situation in which a firm is earning exactly a normal rate of return TR-TC = 0 MC=ATC on a graph
Total Revenue (TR)
the total money received from the sale of a product Price x Quantity
Total Variable Cost (TVC)
the total of all costs that vary with output in the short run unlike fixed costs, TVC tend to increase as production increases TVC = (K x Pk) + (L x Pl) we assume firms choose the cheapest technology
Long-Run any price above P*
there are profits to be made in the industry and new firms will continue to enter
average total costs
total costs divided by the number of units produced.
Economic Profit
total revenue minus total cost, including both explicit and implicit costs
homogenous products
undifferentiated products; products that are identical to, or indistinguishable from, one another This matters for production because it implies a perfectly elastic demand curve in the short run, which is just a horizontal line at the market equilibrium price
Average Variable costs
variable costs per unit of output
Law of Diminishing Returns
when additional units of a variable input are added to fixed inputs, after a certain point, the marginal product of the variable input declines - every firm will face diminishing returns in the which always apply in the short run Meaning every firm finds it progressively more difficult to increase its output as it produced production capacity
short run losses
where supply and demand intersect for an industry is lower than the breaking even point of a firm P<SRAC, there are economic losses (losses=area of rectangle) some firms will exit the industry - when supply decreases eq. price increases and eq. quantity decreases since P*=SRMC=SRAC=LRAC, the industry is in long-run equilibrium
Long-Run only at P*
will profits be equal to 0, and only at P* will the industry be at eq.
Slope of Total Variable Cost curve
∆TVC/∆q = ∆TVC/I=TVC=MC
