EconomicsCh.8
expansion path
a line formed by connecting the points of tangency between isocost lines and the highest respective attainable isoquants.
Isocost Lines
a line that identifies all the combinations of capital and labor that can be purchased at a given total cost. (basically budget lines). The firms cost of operation is not constant but varies with output.
Points of tangency show the maximum output attainable at a given cost as well as the minimum cost necessary
to produce that output.
Law of Diminishing Marginal Returns (2)
ultimately determines how TVC is related to output. Also determines the behavior of marginal cost and average variable costs since they are derived from the TVC relationship.
Profit maximazaiton
also involves selecting the most profitable output from among those on the expansion path.
AFC
declines over the entire range of output as the total amount of fixed cost is spread over ever-larger rates of output.
Because of the law of diminishing marginal returns
the marginal product of labor varies with the amount of output and, therefore, so must marginal cost.
A firm should shift money spent
until the terms become equal
Per unit costs vary
with output along a cost curve because the productivity of the inputs varies with the rate of output. it is assumed that one firm's output will not by itself influence input prices
Short Run marginal cost
equals the price of the variable input divided by its marginal product
Production function in the short-run
the production function relates output to the quantity of variable inputs; fixed inputs do not vary.
Minimum efficient scale
the scale of operations at which average cost per unit reaches a minimum. this basically tells us how many players a particular industry/market can handle if it is .05 of production it can handle approximately 20.
When the firm produces an output in the least costly way, it will satisfy the following conditions
MRTS_LK = w/r
Surveys are
a commonly used method to determine the minimum efficient scale of production in an industry.
Long-run cost is lower than short-run cost
because of the greater flexibility in input usage a firm possesses in the long run.
Golden Rule of Cost minimization
a rule that says that to minimize cost, a firm should employ inputs in such a way that the marginal product per dollar spent is equal across all inputs.
The long-run average cost curve is defined
as the lowest average cost attainable when all inputs are variable.
When marginal cost is above average cost
average cost rises
Total Variable Costs
=wL The cost incurred b a firm that depends on how much output it produces. Wages paid to labor. Depends on how much output it produces. Associated with variable inputs; more output requires the use of more variale inputs. to produce more in the short run, the firm must use more of the variable stuff.
decreasing returns to scale
imply a rising average cost.
when average cost is rising
marginal cost must be above average cost
Total Product Curve
shows the amount of labor used to produce each level of output
The ratio MP_L/W
signifies the increase in output per dollar spent on labor.
Law of diminishing marginal returns (1)
it specifies that increasing the variable input will, beyond some point result in smaller increases in total output
When average cost is declining
marginal cost must be below average cost
The slope of an isoquant is the
marginal rate of technical substitution.
when average cost is at a minimum,
marinal cost is equal to average cost
It is generally assumed
that business firms produce output at the lowest possible cost and will operate somewhere on the expansion path.
Input Substitution effect
the effect of a change in the price of an input on a firm's relative use of the input to produce a given level of output.
decreasing returns to scale
are likely to be common at high output levels.
Increasing returns to scale
are likely to be common at low output levels
Economies of Scope
a case where it is cheaper for one firm to produce products jointly than it is for separate firms to produce the same products independently Multiproducts
Diseconomies of Scope
a case where it is cheaper for separate products to be produced independently than for one firm to produce the same products jointly.
Isocost and Isoquant lines together
allows us to determine what combination of inputs the firm will use to produce various rates of output.
Marginal Cost (MC)
= ΔTC/ ΔQ= ΔTVC/ ΔQ=(ΔL)w/ ΔQ TCQx - TCQy Marginal Cost can also be defined as the change in total variable cost resulting from a one-unit change in output, because the only part of total cost that rises with output is variable cost. Marginal cost relationship shows how much additional cost a firm will infur if it increases output by one unit, or how much cost saving it will realize if it reduces output y one unit.
Total Cost
=TFC+TVC
Total Fixed Cost
=rK+sLand+eET... where r is the rental rate of capital, s is the rental rate of Land, and e is money paid for entrepreneurial talent. The cost incurred by a firm that does not depend on how much output it produces. The FC will be the same, regardless of how much output the firm produces; in particular, if the firm produces nothing, it still incurs its TFC.
Average Variable Cost
TVC/Q
Average Total Cost
TC/Q
new entrant or survivor technique
a method for determining the minimum efficient scale of production in an industry, based on investigating the plant sizes either being built or used by firms in the industry
Short Run
a period of time over which the firm is unable to vary all its inputs.. Some inputs are effectively fixed in the short run.
Economies of scale
a situation in which a firm can increase its output more than proportionally to its total input cost
Production function
identifies the input combinations that can produce a given output, and the prices that must be paid for these inputs.
Constant returns to scale
imply a constant average cost
Learning by doing
improvements in productivity resulting from a firm's cumulative output experince
From among the input combinations it can use
the firm will clearly want to choose the labor-capital combination that yields the greatest output.
Opportunity costs of resrources
the value the resources would generate in their best alternative use. Opportunity costs reflects both explicit and implicit costs.
This condition indicates that the firm
will adjust its employment of inputs so that the rate at which one input can ne traded for another in production will equal the rate at which one input can be substituted for the other in input markets
cubic total cost function
TC=a +bq +cq^2 + dq^3 q= output and abcd and numerical values to be estimated.
Average Fixed Cost
TFC/Q
The assumption that firms minimize cost is based ont he belif that firms are attempting to maximize profit.
To max profit a firm must produce its output at min cost.
When MP_L/W > MP_K/r
a dollar's worth of labor adds more to output than a does a dollars worth of capital
to produce the maximum output possible at a given total cost
a firm should operate at a point where an isocost line is tangent to the highes isoquant attainable. the tangent points also show the least costly way of producing any given output level.
Restated meaning of diminsihing marginal returns
In the region of dimiishing marginal returns, each additional unit of the variable input adds less to total output. That is, each additional unit of output requires more of the variable input than the previous unit. More of the variable input per unit of output means higher cost
How is the law of diminishing marginal returns related to the shape of the short-run marginal cost curve? (Hint: Recall the Principle of Duality.) If the marginal product of the variable input declines from the very start, what will the short-run marginal cost and average cost curves look like? If the marginal product first rises and then falls, what will the cost curves look like?
The Principle of Duality states that there is a one-to-one inverse relationship between marginal product and marginal cost such that the level of output where marginal product is maximized is the level of output where marginal cost is minimized. If marginal product of labor benefits from specialization of labor and at some point suffers from diminishing marginal returns -recall diminishing marginal returns occurs when firms try to increase output by increasing some inputs while holding others fixed—then the marginal product of labor curve will have an upside down U shape. Then because of the principle of duality, the marginal cost curve will have a right side up U shape. If marginal product of labor suffers from diminishing marginal returns from the first worker, then the marginal product curve will decline from the first worker. Consequently, the marginal cost curve will increase from the first unit of output.
At the tangencies
The isoquants and isocost lines have the same slopes.
Diseconomies of scale
a situation in which a firm's output increases less than proportionally to its total input cost.
Implicit Costs
are those associated with the use of the firms own resources and reflect the fact that the use resources could be employed elsewhere. Difficult to measure.
Explicit cost
arise from transactions in which the firm purchases inputs or the services of inputs from other parties. Usually recorded as costs in conventional acconting statements.
Long run can be considered
as a planning or investment horizon.
When marginal cost is below average (total or variable) costs
average cost will decline
Marginal Cost falls
causing the average cost to fall as well. In fact average cost will decline as long as MC lies below it and pulls it down.
The cost of Production marginal cost curve
is u-shaped. The cost of additional units of output first falling, reaching a minimum and then rising MC costs fall at first because FC are very expensive when output is low. Declining MC eventually ends and there is overutilization that causes MC to rise.
Increasing returns to scale
mean that at higher output levels each unit of output requires (on average) a smaller quantity of all inputs also implies that average unit cost is falling
points of tangency between isocost and isoquant lines
show the least costly way of producing each indicated output.
As returns to scale are first increasing and thereafter decreasing
the long-run average cost curve will be u-shaped