# Shared Flashcard Set

## Details

P&R Chaps 6-7 - Production
Production
76
Economics
09/24/2013

Term
 theory of the firm
Definition
 describes how firms make cost-minimizing production decisions and how a firm's result cost varies with its output* assumes that firm is always using cost-minimizing combination of inputs
Term
 3 factors of production
Definition
 1. production technology - how inputs (labor, capital and raw materials) are transformed into outputs2. cost constraints - prices of labor, capital and other inputs3. input choices -- how much of each input to use in producing its output (e.g. if firm operates in country with low wages, may decide to use more labor and less capital and technology)
Term
 production function
Definition
 indicates highest output that a firm can produce for every specified combination of inputsq = F(K,L)[L= Labor, K = Capital, q = production]* applied to a given technology (i.e. understanding that production methods can change)* describes what is technically feasible when the firm operates efficiently
Term
 inputs and outputs are flows
Definition
 *meaning that... unless otherwise indicated, talking about amount of labor and capital used each year and output produced each year
Term
 short run
Definition
 period of time in which quantities of one or more production factors CANNOT be changed(for example, amount of capital is a fixed input.)(over a month or two, a firm is unlikely to be able to substitute very much capital for labor)
Term
 fixed input
Definition
 production factor that cannot be varied (at least one input will be fixed during the short run
Term
 long run
Definition
 amount of time needed to make all production inputs variablei.e.... over time, one can change variables such as capital and labor*changes from one industry to the next. lemonade stand = 3 days. auto plant = 10 years
Term
 short run vs long run
Definition
 in short run, firms vary the intensity with which they utilize a given plant and machinery. in the long run, a firm will vary the size of the plant itself.
Term
 average product
Definition
 output per unit of a particular inpute.g. average product of labor = output/labor input = q/L
Term
 marginal product
Definition
 additional output produced as an input is increased by one unit(usually talking about small changes)
Term
 average product of labor
Definition
 output/labor input = q/L
Term
 marginal product of labor
Definition
 change in output/change in labor input = change q/ change L
Term
 when capital is fixed but labor is variable...
Definition
 only way for firms to increase output is by increasing labor input
Term
 when MP (marginal product) > AP (average product)
Definition
 AP increases
Term
 when MP < AP
Definition
 AP decreases
Term
 AP is maximized where...
Definition
 AP = MP
Term
 slope of total product curve (with fixed capital)
Definition
 change q/change L (or... MPL)
Term
 law of diminishing marginal returns (to labor w/ fixed capital)
Definition
 as the use of an input increases in equal increments (with other inputs fixed), a point will eventually be reached at which the resulting additions to output decrease)*dont confuse diminishing marginal returns with *negative* returns -- the law describes a *declining* marginal product, but not necessarily a negative one.i.e. product usually just increases more slowly and less per worker.
Term
 slope when total output is maximized
Definition
 zero
Term
 effect of technological improvement
Definition
 labor productivity (output per unit of labor) can increase technology improves* delays diminishing returns?
Term
 labor productivity
Definition
 average product of labor for an entire industry (or for the economy as a whole)
Term
 Isoquant
Definition
 Curve showing all possible combinations of inputs that yield the same outputq1 = {L1, K1}*downward sloping and convex(two-variable inputs)
Term
 isoquant map
Definition
 graph combining a number of isoquants, used to describe a production function(firms grow as q increases)
Term
 marginal rate of technical substitution (MRTS)
Definition
 ability of firm to replace one input (capital) with another (labor) while maintaining same level of outputi.e. amount by which the quantity of one input can be reduced when one extra unit of another input is used, so that output remains constantMRTS = - changeK/changeL (for a fixed level of Q)
Term
 slope of isoquant
Definition
 measures MRTS (- changeK/changeL) at any point
Term
 diminishing MRTS
Definition
 MRTS falls as we move down along an isoquant- tells us that productivity for any one input is limited. production usually needs a mix of both inputs (cant rely fully on labor or capital)
Term
 returns to scale
Definition
 rate at which output increases as inputs are increased proportionately
Term
 increasing returns to scale
Definition
 situation in which output more than doubles when all inputs are doubled
Term
 constant returns to scale
Definition
 situation in which output doubles when all inputs are doubled
Term
 decreasing returns to scale
Definition
 situation in which output less than doubles when al inputs are doubled
Term
 accounting cost
Definition
 actual expenses plus depreciation charges for capital equipment.
Term
 economic cost
Definition
 cost to a firm of utilizing economic resources in production, including opportunity cost*"economic" tells us to distinguish between costs that a firm can control and those it cannot.
Term
 opportunity cost
Definition
 cost associated with opportunities that are forgone when a firm's resources are not put to their best alternative use(e.g. guy quitting his job to start a new company)(e.g. a company not renting out the building it owns)
Term
 sunk cost
Definition
 expenditure that has been made and cannot be recoverede.g. equipment that can only be used for its original purpose and cannot be converted for alternative use- or... r&d and marketing costs**the book assumes that firms treat any sunk cost *of capital* as a fixed cost spread out over time
Term
 should sunk costs influence a firm's decisions?
Definition
 no it should not, even though they are more obvious then opportunity costs.
Term
 should opportunity costs influence a firm's decisions?
Definition
 yes they should, even if they are hidden.
Term
 prospective sunk cost
Definition
 - an investmente.g. a firm considering buying specialized equipment. the firm must decide whether the purchase is economical -- i.e. whether it will generate revenues that can justify its cost.
Term
 total cost (TC or C)
Definition
 total economic cost of production, consisting of fixed and variable costs
Term
 fixed costs (FC)
Definition
 cost that does not vary with the level of output -- it must be paid even if there is no output -- and that can be eliminated only by shutting down. eg: rent*over a very short time horizon, most costs are fixed, due to contracts and labor inflexibility
Term
 variable cost (VC)
Definition
 a cost that varies as output varieseg: wages, salaries, raw materials used
Term
 shutting down
Definition
 doesnt necessarily mean going out of business -- can involve downsizing by shuttering certain stores/factories
Term
 amortization
Definition
 policy of treating a one-time expenditure as an annual cost spread out over some number of years
Term
 amortizing sunk costs
Definition
 - shutting down still wont make the annual cost go away (so its not *really* fixed)- still... simplifies economic analysis by, say, making it easier to understand the tradeoff that a firm faces in its use of labor versus capital.
Term
 Marginal Cost (MC)
Definition
 the increase in cost resulting from the production of one extra unit of output- also sometimes called incremental costMC = changeVC/changeQ or... MC = changeTC/changeQ (this is because fixed cost does not change as the firm's level of output changes)
Term
 Average Total Cost (ATC)
Definition
 total cost divided by its level of output
Term
 Average Fixed Cost (AFC)
Definition
 fixed cost divided by level of output (FC/q)- declines as the rate of output increases, since fixed costs are constant.
Term
 Average Variable Cost (AVC)
Definition
 variable cost divided by level of output
Term
 determinants of short-run costs
Definition
Term
 diminishing marginal returns to labor occur when...
Definition
 the marginal product of labor is decreasing (ch. 6)
Term
 if labor is only input...
Definition
 to produce more output, firm must hire more labor. then... if the marginal product of labor decreases as the amount of labor hired is increased (due to diminishing returns), successively greater expenditures must be made the produce output at the higher rate. As a result, variable and total costs increase as the rate of output is increased. on the other hand... if the marginal product of labor decreases only slightly as the amount of labor is increased, costs will not rise so quickly when the rate of output is increased.
Term
 formulas in 7.2
Definition
 check theseMarginal Costs = ∆Variable Costs/∆Q = wages(∆ Labor)/∆ Qtherefore...MC = wages/Marginal Product of labor (MPL)*don't forget: MPL = ∆ in output/∆ in labor input = ∆ q/ ∆ L
Term
 diminishing marginal returns
Definition
 means that the marginal product of labor (MPl) declines as the quantity of labor employed increases.- as a result, when there are diminishing marginal returns, marginal cost will increase as output increases.
Term
 how wages affect MC
Definition
 MC = w/MPl
Term
 the shape of the total cost curve (TC)
Definition
 determined by vertically adding the fixed cost curve to the variable cost curve. (distance between TC and VC is constant)
Term
 whenever the marginal cost curve lies below average cost curve...
Definition
 ... average cost curve falls.
Term
 whenever the marginal cost curve is above the average cost curve...
Definition
 ... average cost curve rises.
Term
 the vertical distance between the ATC curve and the AVC curve...
Definition
 decrease as output increases, because ATC is the sum of AVC and AFC and the AFC curve declines everywhere. * MC = AVC at its minimum point and ATC at its minimum point
Term
 user cost of capital
Definition
 annual cost of owning and using a capital asset, equal to economic depreciation +(interest rate)(value of capital)
Term
 isocost line
Definition
 graph showing all possible combinations that can be purchased for a given total cost. ... K=C/r - (w/r)Lslope: ∆K/∆L = -(w/r)
Term
 rental rate
Definition
 cost per year of renting one unit of capital*in a competitive capital market, the rental rate should be equal to the user cost, ri.e... capital that is purchased can be treated as though it were rented at a rental rate equal to the user cost of capital** book assumes that firm rents all of its capital at a rental rate, or "price" r, just as it hires labor at a wage rate, or "price" w
Term
 when a firm minimizes the cost of producing a particular output...
Definition
 MPl/MPk = w/ror...MPl/w = MPk/rMPl/w is the additional output that results from spending an additional dollar for labor
Term
 expansion path
Definition
 curve passing through points of tangency between a firm's isocost lines and its isoquants- describes the combinations of labor and capital that the firm will choose to minimize costs at each output level* as long as the use of both labor and capital increases with output, the curve will be upward sloping
Term
 long-run average cost curve (LAC)
Definition
 curve relating to average cost of production to output when all inputs, including capital, are variable- U-shaped
Term
 short-run average cost curve (SAC)
Definition
 curve relating to the average cost of production to output when level of capital is fixed- U-shaped
Term
 long-run marginal cost curve (LMC)
Definition
 curve showing the change in long-run total costs as output is increase incrementally by 1 unit.
Term
 LMC and LAC intersect...
Definition
 ... at where the LAC curve achieves its minimum.
Term
 economies of scale
Definition
 situation in which output can be doubled for less than a doubling of cost- marginal cost will be less than average cost (both are falling)- often measured in terms of cost-output elasticity: Ec = (∆C/C)/(∆q/q) = MC/AC
Term
 diseconomies of scale
Definition
 situation in which a doubling of output requires more than a doubling of cost- marginal cost will be higher than average cost (both are rising)
Term
 increasing returns to scale
Definition
 output more than doubles when the quantities of all inputs are doubled(compare this to diseconomies of scale...)
Term
 product transformation curve
Definition
 shows the various combinations of two different outputs (products) that can be produced with a given set of inputs
Term
 economies of scope
Definition
 situation in which joint output of a single firm is greater than the output that could be achieved by two different firms when each produces a single product
Term
 diseconomies of scope
Definition
 situation in which joint output of a single firm is less than could be achieved by separate firms when each produces a single product
Term
 degree of economies of scope
Definition
 percentage of cost savings resulting when two or more products are produced jointly rather than individually.
Term
 learning curve
Definition
 graph relating amount of inputs needed by a firm to produce each unit of output to its cumulative output(don't know if need to know this... more in book)
Term
 cost-output elasticity (Ec)
Definition
 the percentage change in the cost of production resulting from a 1-percent increase in output.*often used to measure economies of scaleEc = (∆C/C)/(∆q/q) or...Ec = (∆C/∆q)/(C/q) = MC/AC
Term
 when there are economies of scale...
Definition
 (i.e. when costs increase less than proportionately with output)- marginal cost is less than average cost (both are declining) - Cost-output elasticity (Ec) is less than 1
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