Unit 3 - The Theory of the Firm

Beth makes gourmet dog treats and wants to increase her output. It takes her 1 hour to acquire more peanut butter, 1 day to acquire more cooking molds, 1 week to hire more workers, 2 weeks to get a new oven, and 4 months to find a new building for a larger bakery. Assume Beth can also sell off these inputs in the same amount of time it takes to obtain them. - How long is the long run for Beth?

4 months

The marginal product of labor is 50 bagels and the average product of labor is 25 bagels. Which of the following best describes what happens if one more unit of labor is used?

APL​ increases

What are the total fixed costs?

All costs that DO NOT change when output changes ~constant amount

What are total variable costs

All costs that DO change when output changes

What is the key feature of the long run?

All resources are variable; no fixed resources and the size and capacity of the factory can change

What is the long run ATC curve made up of?

All the different short run ATC curves of various plant sizes

If a firm operates in a perfectly competitive market, what must be true about the firm's efficiency in the short run and the long run?

Allocatively efficient in the short run; both allocatively efficient and productively efficient in the long run Allocative efficiency occurs when a firm produces the quantity where marginal benefit (MB) equals marginal cost (MC). A perfectly competitive firm always produces the allocatively efficient quantity because the good's price reflects its marginal benefit, and a perfectly competitive firm always produces where P=MR=MC. Productive efficiency occurs when a firm produces the quantity where average total cost is minimized, and a perfectly competitive firm produces this quantity in the long run.

The Law of Diminishing Marginal Returns

As variable resources (workers) are added to fixed resources (ovens, machinery, tool, etc.), the additional output produced from each additional worker will eventually fall

How is average product calculated?

Average product= Total product/ Units of labor

Turkey jerky is produced and sold in a perfectly competitive increasing cost industry and buyers consider it a normal good. The incomes of turkey jerky buyers have increased. What happens to each firm's average total cost curve and the price of turkey jerky in the long run?

Average total cost curves increase; the price of turkey jerky increases.

How is marginal product calculated?

Change in total product/ change inputs

Which of the following best describes the shutdown rule?

Choose Q=0 when P<Average variable cost

When Yooko Industries makes 2000 widgets, the cost of producing a typical widget is $5 which includes implicit costs of $2. What is Yooko Industries economic profit (or loss) and accounting profit (or loss) if the price of a widget is $4?

Economic profit= −$2000 (a loss) Accounting profits=$2000

What are some examples of total variable costs?

Examples includes payments for.. ~ materials ~ fuel/power ~ transportation services ~most labor

What is the equation of average fixed cost?

FC/ Q (fixed cost)/ (quantity of output)

Where does the marginal cost curve intersect the average total cost curve?

From below and crosses it at the lowest point

Which of the following is a way to avoid diminishing marginal returns to labor?

Increase the quantity of capital

What happens to the total cost curve as more output is produced?

It becomes steeper due to the diminishing returns

Which of the following is true about a perfectly competitive firm in the long run?

It produces the quantity where marginal benefit equals marginal cost and the average total cost is minimized.

What happens when the marginal cost is below the average?

It pulls the average down

What happens when the marginal cost is above the average?

It pulls the average up

When does the u-average total cost curve fall at low levels of output?

It then rises at higher levels

What is true about marginal product if total product is maximized?

Marginal product equals zero

What is true about the price of a good that leads firms to exit an industry?

P<ATC

If profit is as high as possible and normal economic profits are being earned, which of the following is true?

P=ATC(Q)P= ATC(Q) and MR(Q)=MC(Q)

Which of the following would entice a firm to enter an industry?

P>ATC

What is long run used for?

Planning for firms to identify which size factory results in the lower per unit cost

Which of the following happens in the long run when demand increases in a perfectly competitive constant cost industry?

Price doesn't change.

Which of following best describes a perfectly competitive firm in the short run and the long run?

Short run: allocatively efficient; long run: allocatively efficient and productively efficient

What is the equation for total fixed costs?

TFC= Q x AVC

When and why does TVC increase?

TVC increases as the quantity increases because the firm needs more labor to make more output

What is the equation for TVC?

TVC= Q x AVC

Average product

The amount of outputs that are produced by an average unit of labor

Which of the following best describes what happens in the long run when a firm anticipates that the price of their good will always be less than average total cost (ATC)?

The firm will exit the industry. If price is less than ATC a firm is making a loss. If a firm knew that this would be the situation forever, and it would forever lose money, the firm would exit the industry.

What is the average fixed cost?

The fixed cost per unit of output

What is the total cost?

The sum of the fixed cost and the variable cost of producing that quantity of output

What is the long-run?

The time period in which all inputs can be varied ~Enough time for a firm to change the quantities of all resources employed, including the plant size

What is the short-run?

The time period in which at least one input is fixed ~NOT a set specific amount of time

What is the key feature of the short run?

The time period in which at least one resource is fixed

What is the average total cost?

The total cost divided by quantity of output produced

What is the average variable cost?

The variable cost per unit of output

What is important to know about the "short-run" and the "long-run"

They are not specific amounts of time

How is average total cost calculated?

Total cost/ quantity of output

What is the equation of average variable cost?

VC/ Q (variable cost)/ (quantity of output)

What does a rational firm consider?

all of the costs and benefits of an action, which means it considers both implicit and explicit costs of an action.

fixed input

an input whose quantity is fixed for a period of time and cannot be varied

variable input

an input whose quantity the firm can vary at any time

All of the following are characteristics of perfectly competitive markets EXCEPT

barriers to entry

How do you find the marginal cost?

change in total cost / change in quantity of output ~ change in total cost generated by one additional unit of output

Which of the following best describes what a firm's objective is?

maximize economic profit

Marginal product

the additional output generated my additional inputs

What is the diminishing returns effect?

the larger the output, the greater the amount of variable input required to produce additional units, which leads to higher average variable cost

What is the spreading effect?

the larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost

Total product (Q)

the relationship between the quantity of inputs a firm uses and the output it produces ex: 10 units of output

production function

the relationship between the quantity of inputs a firm uses and the quantity of output it produces

How do you find the total profit?

total revenue - total cost

When does allocative efficiency occur?

when a firm produces the quantity where marginal benefit (MB) equals marginal cost (MC).

What are the three stages of return?

~ Stage 1: Increasing marginal returns ~ Stage 2: Decreasing marginal returns ~ Stage 3: Negative marginal returns

Why does marginal cost curve go down and then up?

~Diminishing marginal returns to labor in the production function ~As output increases, the marginal product of the variable input (labor) declines ~ This implies that more and more labor must be used to produce each additional unit of output ~ Since each unit of labor must be paid for, the additional cost per additional unit of output also rises

What are some examples of total fixed costs

~Include payment for Rent Interest on firm's debt insurance premiums

What are some examples of short-run costs?

~Labor (wages) ~ Raw materials (resources) ~ Any resource used for production in a fixed plant