ECON CH 8

[Related to the Making the Connection] UPS has reorganized the routes its drivers take to deliver packages to homes. According to an article in the Wall Street Journal, "The company can save $50 million a year by reducing by one mile the average aggregated daily travel of its drivers." Source: Steven Rosenbush and Laura Stevens, "At UPS, the Algorithm Is the Driver," Wall Street Journal, February 16, 2015. ---------------------------------- a. This cost saving is ---------------------------------- b. Suppose that UPS saves $50 million per year because of lower gasoline prices. Would that cost saving be due to technological change at the firm? Briefly explain.

---------------------------------- an example of positive technological change. ---------------------------------- saving that results from the use of lower priced inputs.

What is minimum efficient scale? ---------------------------------- Minimum efficient scale is

---------------------------------- the level of output at which the long−run average cost of production no longer decreases with output.

Explain why the marginal cost curve intersects the average variable cost curve at the level of output where average variable cost is at a minimum. ---------------------------------- The marginal cost curve intersects the average variable cost curve at the level of output where average variable cost is at a minimum because

---------------------------------- when the marginal cost of the last unit produced is below the average, it pulls the average down, and when the marginal cost is above the average, it pulls the average up.

What is likely to happen in the long run to firms that do not reach minimum efficient scale? ---------------------------------- A firm that does not reach its minimum efficient scale

---------------------------------- will lose money if it remains in business.

Technological change

A change in the ability of a firm to produce a given level of output with a given quantity of inputs

Explicit cost

A cost that involves spending money

long-run average cost curve

A long-run average cost curve shows the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed.

Implicit cost

A nonmonetary opportunity cost

average product of labor

Another useful indication of output is the average product of labor, calculated as the total output produced by a firm divided by the quantity of workers

economies of scale

At low quantities, a firm might experience economies of scale: the firm's long-run average costs falling as it increases the quantity of output it produces.

Law of diminishing returns

At some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline

constant returns to scale

At some point, growing larger does not allow more economies of scale. The firm experiences constant returns to scale: its long -run average cost remains unchanged as it increases output.

short run

Economists refer to the short run as a period of time during which at least one of a firm's inputs is fixed. • Example: A firm might have a long-term lease on a factory that is too costly to get out of.

diseconomies of scale

Eventually, firms might get so large that they experience diseconomies of scale: a situation in which a firm's long -run average costs rise as the firm increases output.

For which of the following reason(s) may firms experience economies of scale?

Firm's production may increase with a smaller proportional increase in at least one input. Large firms may be able to purchase inputs at lower costs than smaller competitors; they can also borrow money at a lower interest rate. Both managers and workers may become more specialized and hence more productive as output expands.

average total cost

If we divide the total cost of the pizzas by the number of pizzas, we get the average total cost of the pizzas. For low levels of production, the average cost falls as the number of pizzas rises; at higher levels, the average cost rises as the number of pizzas rises.

long run

In the long run, the firm can vary all of its inputs, adopt new technology, and increase or decrease the size of its physical plant. How long is the long run? It varies from firm to firm. • Just think of it as "a long enough period of time that anything can be changed."

What is the difference between the short run and the long run? ---------------------------------- Is the amount of time that separates the short run from the long run the same for every firm?

In the short run, at least one of a firm's inputs is fixed, while in the long run, a firm is able to vary all its inputs and adopt new technology. ---------------------------------- No

Is it possible for technological change to be negative? If so, give an example.

It is possible for technological change to be negative. An example is when a firm hires less−skilled workers.

Dividing both sides by output (Q) gives a useful relationship:

TC / Q = FC / Q + VC / Q

We know that total costs can be divided into fixed and variable costs:

TC = FC + VC

What is the difference between technology and technological change?

Technology is the process of using inputs to make output, while technological change is when a firm is able to produce the same output using fewer inputs.

the minimum efficient scale

The lowest level of output at which all economies of scale are exhausted is known as the minimum efficient scale

Technology

The processes a firm uses to turn inputs into outputs of goods and services

When the DuPont chemical company first attempted to enter the paint business, it was not successful. According to a company report, in one year it "lost nearly $500,000 in actual cash in addition to an expected return on investment of nearly $500,000, which made a total loss of income to the company of nearly a million." Why did this report include as part of the company's loss the amount it had expected to earn -- but didn't -- on its investment in manufacturing paint? Source: Alfred D. Chandler, Jr., Thomas K. McCraw, and Richard Tedlow, Management Past and Present,Cincinnati: South-Western, 2000, pp. 3-92.

The report sought to include implicit costs because DuPont could have invested its money elsewhere and earned $500,000.

Briefly explain whether you agree with the following observation: "Technological change refers only to the introduction of new products, so it is not relevant to the operations of most firms."

The statement is incorrect. Technology includes firm operations such as the training of its workers. The statement is incorrect. Technology includes firm operations such as the speed of its machinery.

marginal product of labor

To think about this, consider the marginal product of labor: the additional output a firm produces as a result of hiring one more worker. • The first worker increases output by 200 pizzas; the second increases output by 250

marginal cost

We can also define the marginal cost as the change in a firm's total cost from producing one more unit of a good or service: 𝑀𝐶 = ∆𝑇𝐶 /∆Q

What are implicit costs? An implicit cost is ---------------------------------- How are implicit costs different from explicit costs?

a nonmonetary opportunity cost. ---------------------------------- An explicit cost is a cost that involves spending money, while an implicit cost is a nonmonetary cost.

An example of technological change is

being able to produce more output using the same inputs. being able to produce the same output using fewer inputs. a decline in the quantity of output that can be produced from a given quantity of inputs.

What is a production function? A firm's production function is best described as

illustrating the relationship between inputs and the maximum amounts of output that the firm can produce with these inputs.

Total cost

is the cost of all the inputs a firm uses in production (Total cost = Fixed cost + Variable cost 𝑇𝐶 = 𝐹𝐶 + 𝑉C)

What does the short-run production function hold constant? A short-run production function holds constant

the amount of capital.

Refer to the table below. Which of the following costs are implicit costs? Type of Cost Amount Paper $20,000 Wages 48,000 Lease payment for copy machines 10,000 Electricity 6,000 Lease payment for store 24,000 Foregone salary 30,000 Foregone interest 3,000 Total 141,000 ---------------------------------- Which of the following are sometimes called accounting costs?

the forgone salary and interest ---------------------------------- explicit costs

What is technology? Technology is

the processes a firm uses to turn inputs into outputs of goods and services.

Production function

the relationship between the inputs employed and the maximum output from those inputs

Economies of scale occur

when a firm's long-run average costs decrease with output.

• The first quantity is ______________. • The second is _____________________: fixed cost divided by the quantity of output produced. • The third is _____________________: variable cost divided by the quantity of output produced. So, ATC = AFC + AVC

• The first quantity is average total cost. • The second is average fixed cost: fixed cost divided by the quantity of output produced. • The third is average variable cost: variable cost divided by the quantity of output produced. So, ATC = AFC + AVC

The division of time into the short and long run reveals two types of costs:

• Variable costs are costs that change as output changes, while • Fixed costs are costs that remain constant as output changes. In the long run, all of a firm's costs are variable, since the long run is a sufficiently long time to alter the level of any input.

Xylo Corporation is a large manufacturer of solar panels in the town of Southville. It is not only a major employer of the town's population, but also attracts a large number of workers from the neighboring county of Canning which has very few job opportunities. Based on industry reports that indicated a substantial increase in installed solar power capacity in the last two years, Xylo introduced new production technology to increase efficiency and lower costs at its Southville plant. The senior management decided that they would increase production of solar panels by 20 percent in the coming year to meet the higher demand. They also felt that lower costs, along with high expected demand, would help them to improve profit margins. However, Wilma Myers, the firm's operationshead, is not so optimistic about the demand conditions. She feels that the sales in the coming year may not be as high as the senior management is anticipating. ---------------------------------- Which of the following, if true, would weaken the management's view that the new technology and higher demand would increase profit margins?

---------------------------------- Due to improving employment conditions in Canning County, many workers in Southville moved back to their hometowns.

Xylo Corporation is a large manufacturer of solar panels in the town of Southville. It is not only a major employer of the town's population, but also attracts a large number of workers from the neighboring county of Canning which has very few job opportunities. Based on industry reports that indicated a substantial increase in installed solar power capacity in the last two years, Xylo introduced new production technology to increase efficiency and lower costs at its Southville plant. The senior management decided that they would increase production of solar panels by 20 percent in the coming year to meet the higher demand. They also felt that lower costs, along with high expected demand, would help them to improve profit margins. However, Wilma Myers, the firm's operations head, is not so optimistic about the demand conditions. She feels that the sales in the coming year may not be as high as the senior management is anticipating. ---------------------------------- Which of the following, if true, would weaken Wilma's claim that sales in the coming year may not be very high?

---------------------------------- Government banks will now offer loans at interest rates below the market rate for those who want to install solar power rooftops in their homes and businesses.

Sally looks at her college transcript and says to you, "How is this possible? My grade point average (GPA) for this semester's courses is higher than my GPA for last semester's courses, but my cumulative GPA still went down from last semester to this semester." ---------------------------------- Explain to Sally how this is possible.

---------------------------------- Sally's GPA for this semester is lower than her cumulative GPA.

Xylo Corporation is a large manufacturer of solar panels in the town of Southville. It is not only a major employer of the town's population, but also attracts a large number of workers from the neighboring county of Canning which has very few job opportunities. Based on industry reports that indicated a substantial increase in installed solar power capacity in the last two years, Xylo introduced new production technology to increase efficiency and lower costs at its Southville plant. The senior management decided that they would increase production of solar panels by 20 percent in the coming year to meet the higher demand. They also felt that lower costs, along with high expected demand, would help them to improve profit margins. However, Wilma Myers, the firm's operations head, is not so optimistic about the demand conditions. She feels that the sales in the coming year may not be as high as the senior management is anticipating. ---------------------------------- Which of the following, if true, would strengthen Wilma's point of view?

---------------------------------- The industry forecasts of higher demand were based on factory shipments of solar panels, not installations.

Firms experience economies of scale for several reasons. What is one such reason? ---------------------------------- A firm might experience economies of scale because

---------------------------------- as a firm expands, it may be able to borrow money more inexpensively.

[Related to the Don't Let This Happen to You] In his autobiography, T. Boone Pickens, a geologist, entrepreneur, and oil company executive, wrote: It's unusual to find a large corporation that's efficient ... When you get an inside look, it's easy to see how inefficient big business really is. Most corporate bureaucracies have more people than they have work. Source: T. Boone Pickens, The Luckiest Man in the World, Washington, DC: Beard Books, 2000, p. 275. ---------------------------------- Pickens was describing

---------------------------------- diseconomies of scale, because he is referring to the inefficiency of a large scale business operation.

Which of the following are examples of a firm experiencing positive technological change? ---------------------------------- a. A firm is able to cut each worker's wage rate by 10 percent and still produce the same level of output. This _______ an example of positive technological change. ---------------------------------- b. A training program makes a firm's workers more productive. This ____ an example of positive technological change. ---------------------------------- c. An exercise program makes a firm's workers more healthy and productive. This ____ an example of positive technological change. ---------------------------------- d. A firm cuts its workforce and is able to maintain its initial level of output. This ______ an example of positive technological change. ---------------------------------- e. A firm rearranges the layout of its factory and finds that by using its initial set of inputs, it can produce exactly as much as before. This ________ an example of positive technological change.

---------------------------------- is not ---------------------------------- is ---------------------------------- is ---------------------------------- is ----------------------------------is not

[Related to the Making the Connection] Small business owner Jay Goltz described several decisions he made to reduce the fixed costs of his businesses, including replacing halogen lamps with LED lamps. Goltznoted, "...I'm guessing that many business owners could save a lot more than pennies on their fixed costs, and those savings...fall right to the bottom line." Source: Jay Goltz, "Not All Fixed Costs Are Truly Fixed," New York Times, May 25, 2011. ---------------------------------- a. The cost of electricity used to power the lights used in Mr. Goltz' businesses are fixed costs because these costs ---------------------------------- b. Goltz wrote that reducing fixed costs results in savings that "fall right to the bottom line" because

---------------------------------- must be paid regardless of the volume of output. ----------------------------------profit, the bottom line, is revenue minus fixed costs minus variable costs, so a reduction in fixed costs increases profit.