Chapter 8: Cost and the Supply of Goods

question

Residual Claimant

answer

the stockholder receives whatever remains after all other claims against the firm's assets have been satisfied

question

2 Methods of Production:

answer

1. Contacting
2. Team Production

question

Contacting

answer

independent workers

question

Team Production

answer

team of employees' w/ supervision
ex. construction of a house

question

Problems with Team Production:

answer

1. 'Shirking' - reduced productivity
2. 'Principal-Agent Problem' - buyer = principal, seller = agent
3. Needs incentives and monitoring

question

Three Types of Business Firms:

answer

1. Proprietorship
2. Partnership
3. Corporation

question

Proprietorship

answer

1. a single owner
2. unlimited liability

question

Partnership

answer

1. two or more owners
2. unlimited liability
3. 10% of all firms in US
4. 14% business revenue of all firms in US

question

Corporation

answer

1. owned by stockholders
2. owner's liability limited to explicit investment

question

Disadvantage of Corporations

answer

- owners do not equal managers
- NEED FOR incentives and monitoring

question

Limited Liability Company (LLC)

answer

- a form of business ownership that offers both limited liability to its owners and flexible tax treatment
- 1977

question

Advantages of LLC

answer

limited liability, tax pass-through, simplicity and flexibility in management and operation, flexible ownership

question

3 factors to promote cost efficiency:

answer

1. Competition for Investment Funds
2. Compensation for Managers
3. Corporate Takeover 'Threat'

question

Competition for Investment Funds

answer

- stock goes up = goof
- stock goes down = bad
- stockholder's monitor stock Prices
- stock P's increase... signals management is doing well

question

Compensation for Managers

answer

management incentives ~ share of profits

question

Corporate Takeover Threat

answer

takeovers = new owner, restructure possible layoffs

question

Corporate Structure

answer

- generally cost-efficient
- been around since 1862

question

What will be produced?

answer

whatever is in demand

question

For whom will it be produced?

answer

whomever can afford it

question

How will we produce it?

answer

produce as efficiently as possible

question

Total Profits

answer

= Total Revenue - Total costs

question

Total Costs

answer

1. explicit costs
2. implicit costs

question

Explicit Costs

answer

- cost of resources
ex. raw materials, rent, mortgage, utilities

question

Implicit Costs

answer

- opportunity costs
- resources already owned by firm
ex. owner's time, owner's capital (financial investment), current market rate of return)

question

Calculating Accounting Profit

answer

1. total revenue - explicit costs

question

Calculating Economic Profit

answer

total revenue - explicit and implicit costs

question

Economic Profits < 0

answer

not good

question

Economic Profits > 0

answer

good

question

Economic Profits = 0

answer

good
earning market rate of return

question

Fixed Costs

answer

capital, machinery, plant, lease, insurance premiums, property taxes

question

Variable Costs

answer

labor, raw materials

question

Short Run

answer

1. one or more factors of production (input) are fixed
2. output altered ONLY by changing the variable resources
3. NOT enough time to Enter/Exit the industry

question

Long Run

answer

1. firms can alter ALL factors of production, Fixed and Variable
2. firms can enter/exit in the industry

question

Calculate Total Cost

answer

total fixed cost + total variable cost

question

Calculate Average Total Cost

answer

total cost/ average fixed cost + average variable cost

question

Calculate Marginal Cost

answer

the change in your total cost / change in your total fixed costs

question

Productivity ultimately determines....

answer

costs

question

Total Product (TP) curve

answer

as Q input increases, Q output ...
1. increases rapidly
2. then increases slowly, diminishing returns
3. then decreases

question

Marginal Product (MP) Curve

answer

reflects slope values along TP curve
1. TP increases at increases rate... slop increasing values
2. TP increases at decreasing rate... slope decreasing values
3. TP reaches maximum...slope = zero
4. TP decreases ... slope becomes negative

question

Law of Diminishing Returns

answer

As increasing quantities of a variable input is added to a fixed input, the additional output will eventually begin to fall

question

Shape of the Cost Curves

answer

based on shape of total product curve and understanding the Law of Diminishing Returns

question

NOT enough employees...

answer

costly!

question

TOO many employees...

answer

costly!

question

Total Fixed Costs Curve on a graph

answer

constant flat

question

Average Fixed Costs on a graph

answer

continues to decrease as Q output expands

question

Average Variable Cost on a graph

answer

U-shaped

question

Average Total Cost on a graph

answer

U-shaped

question

Marginal Cost Curves on a graph

answer

Looks like a check mark

question

Long Run Cost Curves are called

answer

Planning Curve

question

LRATC graphs do what

answer

maps the surface of all the minimum points of 'Short Run' ATC curves possible

question

Three sections of Long-run ATC

answer

1. Economies of Scale
2. Constant returns to scale
3. Diseconomies of scale

question

Economies of Scale

answer

factors that cause a producer's average cost per unit to fall as output rises

question

Reasons for Economies of Scale

answer

- Spreads the TFC with mass productions
- Specializes at what they do best and learn by doing

question

Constant Returns of Scale

answer

the situation in which a firm's long-run average costs remain unchanged as it increases output

question

Diseconomies of Scale

answer

the situation in which a firm's long-run average costs rise as the firm increases output

question

Reasons for Diseconomies of Scales

answer

- Bureaucratic inefficiencies
- Inflexible procedure
- Principle-Agent problems
- Law of Diminishing Returns

question

Cost Curve Shifters

answer

1. price of resources
2. taxes
3. regulations
4. technology

question

Sunk Costs

answer

costs that are made in the past and cannot be recovered

question

Making a Supply decision for short run use.....

answer

Marginal Cost

question

Making a Supply decision for long run use.....

answer

average total cost

1 of 60

question

Residual Claimant

answer

the stockholder receives whatever remains after all other claims against the firm's assets have been satisfied

question

2 Methods of Production:

answer

1. Contacting
2. Team Production

question

Contacting

answer

independent workers

question

Team Production

answer

team of employees' w/ supervision
ex. construction of a house

question

Problems with Team Production:

answer

1. 'Shirking' - reduced productivity
2. 'Principal-Agent Problem' - buyer = principal, seller = agent
3. Needs incentives and monitoring

question

Three Types of Business Firms:

answer

1. Proprietorship
2. Partnership
3. Corporation

question

Proprietorship

answer

1. a single owner
2. unlimited liability

question

Partnership

answer

1. two or more owners
2. unlimited liability
3. 10% of all firms in US
4. 14% business revenue of all firms in US

question

Corporation

answer

1. owned by stockholders
2. owner's liability limited to explicit investment

question

Disadvantage of Corporations

answer

- owners do not equal managers
- NEED FOR incentives and monitoring

question

Limited Liability Company (LLC)

answer

- a form of business ownership that offers both limited liability to its owners and flexible tax treatment
- 1977

question

Advantages of LLC

answer

limited liability, tax pass-through, simplicity and flexibility in management and operation, flexible ownership

question

3 factors to promote cost efficiency:

answer

1. Competition for Investment Funds
2. Compensation for Managers
3. Corporate Takeover 'Threat'

question

Competition for Investment Funds

answer

- stock goes up = goof
- stock goes down = bad
- stockholder's monitor stock Prices
- stock P's increase... signals management is doing well

question

Compensation for Managers

answer

management incentives ~ share of profits

question

Corporate Takeover Threat

answer

takeovers = new owner, restructure possible layoffs

question

Corporate Structure

answer

- generally cost-efficient
- been around since 1862

question

What will be produced?

answer

whatever is in demand

question

For whom will it be produced?

answer

whomever can afford it

question

How will we produce it?

answer

produce as efficiently as possible

question

Total Profits

answer

= Total Revenue - Total costs

question

Total Costs

answer

1. explicit costs
2. implicit costs

question

Explicit Costs

answer

- cost of resources
ex. raw materials, rent, mortgage, utilities

question

Implicit Costs

answer

- opportunity costs
- resources already owned by firm
ex. owner's time, owner's capital (financial investment), current market rate of return)

question

Calculating Accounting Profit

answer

1. total revenue - explicit costs

question

Calculating Economic Profit

answer

total revenue - explicit and implicit costs

question

Economic Profits < 0

answer

not good

question

Economic Profits > 0

answer

good

question

Economic Profits = 0

answer

good
earning market rate of return

question

Fixed Costs

answer

capital, machinery, plant, lease, insurance premiums, property taxes

question

Variable Costs

answer

labor, raw materials

question

Short Run

answer

1. one or more factors of production (input) are fixed
2. output altered ONLY by changing the variable resources
3. NOT enough time to Enter/Exit the industry

question

Long Run

answer

1. firms can alter ALL factors of production, Fixed and Variable
2. firms can enter/exit in the industry

question

Calculate Total Cost

answer

total fixed cost + total variable cost

question

Calculate Average Total Cost

answer

total cost/ average fixed cost + average variable cost

question

Calculate Marginal Cost

answer

the change in your total cost / change in your total fixed costs

question

Productivity ultimately determines....

answer

costs

question

Total Product (TP) curve

answer

as Q input increases, Q output ...
1. increases rapidly
2. then increases slowly, diminishing returns
3. then decreases

question

Marginal Product (MP) Curve

answer

question

Law of Diminishing Returns

answer

As increasing quantities of a variable input is added to a fixed input, the additional output will eventually begin to fall

question

Shape of the Cost Curves

answer

based on shape of total product curve and understanding the Law of Diminishing Returns

question

NOT enough employees...

answer

costly!

question

TOO many employees...

answer

costly!

question

Total Fixed Costs Curve on a graph

answer

constant flat

question

Average Fixed Costs on a graph

answer

continues to decrease as Q output expands

question

Average Variable Cost on a graph

answer

U-shaped

question

Average Total Cost on a graph

answer

U-shaped

question

Marginal Cost Curves on a graph

answer

Looks like a check mark

question

Long Run Cost Curves are called

answer

Planning Curve

question

LRATC graphs do what

answer

maps the surface of all the minimum points of 'Short Run' ATC curves possible

question

Three sections of Long-run ATC

answer

1. Economies of Scale
2. Constant returns to scale
3. Diseconomies of scale

question

Economies of Scale

answer

factors that cause a producer's average cost per unit to fall as output rises

question

Reasons for Economies of Scale

answer

- Spreads the TFC with mass productions
- Specializes at what they do best and learn by doing

question

Constant Returns of Scale

answer

the situation in which a firm's long-run average costs remain unchanged as it increases output

question

Diseconomies of Scale

answer

the situation in which a firm's long-run average costs rise as the firm increases output

question

Reasons for Diseconomies of Scales

answer

- Bureaucratic inefficiencies
- Inflexible procedure
- Principle-Agent problems
- Law of Diminishing Returns

question

Cost Curve Shifters

answer

1. price of resources
2. taxes
3. regulations
4. technology

question

Sunk Costs

answer

costs that are made in the past and cannot be recovered

question

Making a Supply decision for short run use.....

answer

Marginal Cost

question

Making a Supply decision for long run use.....

answer

average total cost

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