Microeconomic Theory Exam 3 Conceptual Question

What is the difference between a production function and an isoquant?

A production function describes the maximum output that can be achieved with any given combination of inputs. An isoquant indentifies all of the different combinations of the inputs that can be used to produce one particular level of output.

SRATC is typcially U-shaped because as output increases, AFC decreases, but _____ increases.

AVC

Explain why the marginal rate of technical substitution is likely to diminish as more and more labor is substituted for capital.

As the quantities of the inputs are changed the marginal product of each input will change. As more and more labor is added, the marginal product of labor will diminish. Because capital has been reduced. each unit of campit is likely to be more productive. Thus, as more units of labor will be required to replace each unit of capital. Fewer units of capital need to be given upfor each unit of labor added to keep output constant.

If the firm's average cost curves are U-shaped, why does its average variable cost curve achieve its minimum at a lower level of output than the average total cost curve?

Because average total cost is equal to average fixed cost plus average variable cost.

Isoquants can be convex, linear, or L-shaped. What does deach of these shapes tell you sbout the nature of the production function and the MRTS?

Convex - Imply that within some range, some number of units of one input can be substituted for a unit of the other input so that output is maintained at the same level. MRTS is diminishing as you move along the isoquant. Linear - Imply that the slope, or MRTS, is constant, meaning that the same number of units of one input can always be exchanged for a unit of the other input so that output is maintained. L-Shaped - Imply that the inputs are perfect complements, or that the firms is producing under a fixed level of technology. In this case, the firm cannot give up one input in exchange for the other and still maintain the same level of output.

How does a long-run production funtion differ from a short-run production function?

In the short-run, one of the inputs is fixed, usually capital

What is the marginal rate of technical substitution (MRTS)?

MRTS is the amount by which the quantity of one input can be reduced when the other input is increased by one unit, while maintaining the same level of input.

Can a firm have a production function that exhibits increasing returns to scale, constant returns to scale, and decreasing returns to scal as output increases?

Many firms have production funtions that exhibit first increasing, then constant, and ultimately decreasing returns to scale. At low levels of output, a proportional increase in all inputs may lead to a larger-than-proportional increase in output. As the firm grows, the opportunities for specialization may diminish, and the firm operates at peak efficiency. At some level of output, the firm will be so large that when inputs are doubles, output will less than double.

Assime that the marginal cost of production is increasing. Can you determine whether the average variable cost is increasing or decreasing?

No - When the marginal cost is increasing, the average cost can either be increasing or decreasing

Why are isocost lines straight lines?

The isocost line represents all possible combinations of two inputs that may be purchased for a given total cost. The slope of the isocost line is the negative ratio of the input prices. If the input prices are fixed, their ratio is constant and the isocost line is therefore straight. Only if the ratio of the input prices changes as the quantities change is the isocost line not straight.

Why is the marginal product of labor more likely to increase initially in the short run as more of the variable input is hired?

The marginal product is likely to increase because when there are more workers, each is able to specialize on an aspect of the production process.

Why does production eventually experience diminishing marginal returns to labor in the short-run?

The marginal product of labor will eventually dimishish because there will be at least one fixed factor of production, such as captial. With capital fixed, the workplace will eventually become so congested that the productivity of additional workers will decline. As more workers are added, they will need to share the fixed capital, which will cause the marginal product of labor to diminish as the capital is spread across too many workers.

If a firm enjoys economies of scale up to a certain output level, the cost then increases proportionately with output, what can you say about the shape of the long-run average cost curve?

When a firm experiences economics of scale, its long-run average cost curve is downward sloping. When costs increase proportionately with output, the firm's long-run average cost curve is horizontal. So this firm's long-run average cost curve has a rounded L-shape; first it falls the it becomes horizontal as output increase.

Faced with constantly changing conditions, why would a frim ever keep any factors of production fixed? What criteria determine whether a factor is fixed or variable?

Whether a factor is fixed or not depends on the time horizon. All factors are fixed in the short-run and all factors are variable in the long-run. Some factors are fixed in the short-run whether the firm likes it or not because it takes time to adjust the level of the variables, such as factory space or employee contracts.

Is it possible to have diminishing returns to a single factor of production and constant returns to scale at the same time?

Yes - Diminishing returns to a single factor occurs because all other inputs are fixed. Thus as more and more of the variable factor is used, the additions to output eventually decrease because there are no increases in the other factor. Returns to scale, on the other hand, deals with the increase in output when ALL factors are increased by the same proportion. While each factor of production exhibits diminishing returns, output may more than double, less than double, of exactly double when all factors are doubled.

Assume that the marginal cost of production is greater than the average variable cost. Can you determine whether the average variable cost is increasing or decreasing?

Yes - The average variable cost is increasing. If marginal cost is above average cost, each additional unit costs more to produce than the average of the previous units, so the average variable cost is pulled upward.

You are an employer seeking to dill a vacant position on an assembly line. As you more concerned with the average product of labor or the marginal product of labor for the last person hired? If you observe that your average product is beginning to decline, should you hire any more workers? What does this situation imply about the marginal product of your last worker hired?

You should be more concerned with the marginal product of the last worker hired because the marginal product measures the effect on output of hiring another worker. This can help determine the revenue generated by hiring another worker, which can be compared to the cost of hiring another worker. Where average product declines is where average product is equal to marginal product. When average product declines, the marginal product of the last worker hired is lower than the average product of previously hired workers. Although adding more workers results in a further decline of average product, total product continues to increase, so it may still be advantageous to hire another worker.

A firm's long run expansion path is

a curve that shows the last-cost combination of inputs needed to produce each level of output for given input prices

What is a production function?

a function showing the highest output a firm can produce for every specified level combination of inputs

The short-run expansion path for this production system is

a horizontal line

True or False: a. If the owner of a business pays himself no salary, then the accounting cost is zero, but the economic cost is positive. b. A firm that has a positive accounting profit does not necessarily have positive economic profit. c. If a firm hires a currently unemployed worker, the opportunity cost of utilizing the worker's services is zero.

a. True - Since there is no monetary transation, there is no accounting cost. However, since the owner of the business could be employed elsewhere, there is an economic cost. The economic cost is positive, reflecting the opportunity cost of the owner's times and would be equal to the owner's time in his next best alternative. b. True - Accounting profit only considers the monetary costs. Since there may be some opportunity costs that were not fully realized as explicit monetary costs, it is possible that when the opportunity costs are added in, economic profit will become negative. c. False - From the firm's POV, the wage paid to the worker is an explicit cost. The firm's opportunity cost is equal to the wage because it could have hired someone else at the same wage. The opportunity cost from the worker's POV is the value of their time which is unlikely to be zero and is equal to the worker's next best alternative.

Decreasing returns to scale demonstrate that

as inputs are increased by a factor of x, output is increased by a factor of less than x

Inceasing returns to scale demonstrate that

as inputs are increased by a factor of x, output is increased by a factor of more than x

Constant returns to scale demonstrate that

as inputs are increased by a factor of x, output is increased by the same factor of x

Capital and labor are perfect substitues in a business firm's production process. If w=2 and r=1, a firm will employ only _________.

capital

In the short-run, __________ is asumed to be the fixed input.

capital

A straight-line isoquant would indicate that

capital and labor are perfect substitutes in production

An L-shaped isoquant would indicate that

capital and labor cannot be substituted for each other in production

When a small firm in my inductry produces at minimum SRATC, its cost per unit is equal to that of a much larger firm producing as its minimum SRATC. This is evidence that returns to scale are ________.

constant

As output increases, a firm notices that average productivity of labor decreases. At the same time, it will notice that average fixed costs _________.

decreases

If doubling all inputs results in tripling output, then the slop of the LRAC curve is ____________.

decreasing

In the short-run, on the K L graph, the slope of the expansion path is ___________.

horizontal

A business firm is paying 10 times as much for a unit of labor as they do for a unit of capital. If MPL=MPK, then, in the long-run, the firm should _____________ its capital-labor ratio.

increase

An isocost line reveals the

input combinations that can be purchased with a given outlay of funds

When the average product is decreasing, margianl product

is less than average product

A firm uses two factors of production. Both factors always have positive marginal products which imply that

isoquants have a negative slope

A line that connects all of the possible tangency points in the long-run is known as the _______________________________.

long-run expansion path

When an isocost line is just tangent to an isoquant, then

output is being produced at minimum cost

The marginal rate of technical substitution is equal to the

ratio of the marginal products of the inputs

According to the law of diminishing returns

the marginal product of an input will eventually decline

If a firm's MRTS is 3, this implies

the marginal product of labor is three times the marginal product of capital

A business owner believes that toal cost is minimized if they set MPL=MPK figuring they are getting just as much additional output from a unit of capital as from a unit of labor. This is indeed cost minimizing only if __________.

w=r