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factors of production
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the inputs in the production process
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production function
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specifies the maximum amount of output, q, that can be produced from any combination of inputs, (l,k)
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isoquant
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set of all combinations of inputs, (l,k), that can produce a given level of output, q, and no more (analogous to an indifference curve, where l and k is the analog to goods and q is the analog to utility)
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marginal product
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additional output produced from an increase in an input (analogous to marginal utility)
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average product
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output per unit of input
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marginal rate of technical substitution
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specifies the rate at which capital can be substituted for one unit of labor keeping output constant; also is the absolute value of the slope of an isoquant at any point
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assumption 1 of production functions
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"more is better", which is similar to monotonicity; each additional unit of labor or capital has a positive marginal product, meaning more output; this assumption may not hold if there is congestion (ex: too many cooks in a kitchen)
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assumption 2 of production functions
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k and l are complementary factors; this means that if k is increased the marginal product of l increases and if l is increased the marginal product of k increases
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assumption 3 of production functions
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law of diminishing marginal returns; this means that as the use of an input increases, holding other inputs fixed, the resulting additions to output will eventually decrease (think of it as additional hours of labor service result in smaller and smaller increases in output)
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constant returns to scale
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if we double the amount of inputs, the output is exactly doubled (remember, an increase in returns to scale is when the output is beyond doubled and a decrease in returns to scale is when the output is below doubled)
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short run
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a period of time in which quantities of one or more inputs cannot be adjusted
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fixed inputs
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those inputs that cannot be adjusted
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accounting costs
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consist of actual expenditures incurred by the firm (plus depreciation of capital)
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opportunity cost
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the cost of forgoing the next best alternative
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economic costs
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the total cost of utilizing resources; includes accounting costs and opportunity costs
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sunk cost
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an expenditure that has already been made and cannot be recovered
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isocost line
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the set of all combinations of labor and capital that cost the same amount
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cost function
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tells us how cheaply q units of output can be produced, given prices of labor and capital
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fixed cost
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a cost that does not change with the level of output
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variable cost
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a cost that changes with the level of output
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total cost
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total economic cost of production, otherwise known as fixed cost plus variable cost
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why are short run cost curves always above long run cost curves?
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because in the long run, the firm can choose the optimal proportion of capital and labor
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average cost
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costs per unit of output
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marginal cost
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the increase in cost resulting from the production of an additional unit of output
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MC (q) = what
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(dVC(q))/dq
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If AVC (q) is decreasing, then...
If AVC (q) is increasing, then...
If AVC (q) is constant, then...
If AVC (q) is increasing, then...
If AVC (q) is constant, then...
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...MC (q) < AVC (q)
...MC (q) > AVC (q)
...MC (q) = AVC (q)
...MC (q) > AVC (q)
...MC (q) = AVC (q)
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economics of scale
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when increasing outputs reduces average costs
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profit
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the difference between revenue and cost
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MR (q) < MC (q)
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the last unit produced brings in less revenue than the cost of production, meaning the firm loses money on that unit
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MR (q) > MC (q)
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the last unit produced brings in more revenue than the cost of production, meaning the firm should produce more output because the additional units will be profitable
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assumption 1 for perfect competition
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homogeneity: products are very similar to each other; this means the firm will face an infinitely elastic demand curve; homogeneous products are also known as commodities
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assumption 2 for perfect competition
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firms are price takers; this means they take prices simply as given, rather than influencing them with supply decisions; they will produce when price equals marginal cost
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assumption 3 for perfect competition
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free entry (or exit); no special costs that make it difficult for a new firm to enter or exit an industry; this means zero economic profit in the long run
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shutting down
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producing zero output
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3 conditions of partial equilibrium
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1) firms are maximizing profits
2) consumers are maximizing utilities
3) markets clear (aggregate supply equals aggregate demand)
2) consumers are maximizing utilities
3) markets clear (aggregate supply equals aggregate demand)
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consumer surplus
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the difference between the price that consumers pay and the price they are willing to pay
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producer surplus
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the difference between the price that producers are willing to accept to produce a good and the price
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deadweight loss
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the difference in production and consumption of any given product or service including government tax
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why would a firm keep factors fixed?
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because it takes time to adjust the level of variables
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can an isoquant ever slope upward?
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no because it would imply that adding both inputs keeps output constant
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the point where average cost reaches its minimum value is also known as where average cost equals...
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marginal cost
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when the cost minimizing combination of inputs is being used and there is no corner solution...
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the isoquant line is tangent to the isocost line
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when the average cost curve is decreasing, we have:
when the average cost curve is increasing, we have:
when the average cost curve is increasing, we have:
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economies of scale
diseconomies of scale
diseconomies of scale
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if a perfectly competitive firm finds that it is producing an output level where price is above average variable cost but less than marginal cost, it should
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decrease its output because the marginal cost is greater than the price
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a perfectly competitive firm is producing the output that maximizes its profit. If its fixed cost increases, and industry price remains constant, how should it respond in the short run?
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it should keep the output the same
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average costs tell us whether a firm should produce at all and how much a firm should produce
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-if the price is more than average cost, the firm should shut down; if it's less than average cost, the firm should stay in business
-if the price is less than marginal cost, the firm should produce less; if it's more than marginal cost, the firm should produce more
-if the price is less than marginal cost, the firm should produce less; if it's more than marginal cost, the firm should produce more
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