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Econ 4351 chapter 7
Terms in this set (84)
Two step procedure for determining how to produce a certain amount of output efficiently
It first determines which production processes are technologically efficient so that it can produce the desired level of output with the least amount of inputs. And secondly, the firm picks from these technologically efficient production process the one that is also economically efficient
Minimizing the cost of producing a specified amount of output. To determine which process minimizes its cost of production, the firm uses information about the production function and the cost of inputs
Labor, energy, materials
Direct out of pocket payments for inputs to its production process within a given time period
Reflect a forgone opportunity father than an explicit current expenditure. Requires particularly careful attention when dealing with durable capital goods, as past expenditures for an input may be irrelevant to current cost calculations if that input has no current alternative use q
Economic cost of opportunity cost
The value of the best alternative use of a resource. Includes both explicit and implicit costs
This concept becomes particularly useful when the firm uses an input that is not available for purchase in a market or that it purchased in a market in the past
Example of an opportunity cost
The value of a managers time. For instance, Mike owners and manages a firm. He pays himself only a small monthly salary of $1000 because he also receives the firms profit. However, Mike could work for another firm and earn $11,000 a month. Thus the opportunity costs of his time is $11,000, not the $1,000 he pays himself
Phrase that captures an implicit opportunity cost
Theres no such thing as free lunch
Why do MBA applications rise in bad economic times?
People thinking of going back to school face a reduced opportunity cost of entering an MBA program if they think they might be laid off or might not be promoted during an economic downturn
A product that is usable for years, such as capital
Two problems that may arise in measuring cost of capital
How to allocate the initial purchase cost over time
What to do if the value of the capital changes overtime
We can avoid the two measurement problems of cost of capital if.......
The capital is rented.
Ex: A firm can rent a small pick up truck for $400 a month or buy for $20,000. If the firm rents the truck, the rental payment is the relevant opportunity cost per month. The truck is rented month to month, so the firm does not have to worry about how to allocate the purchase cost of a truck over time. Moreover, the rental rate will adjust if the cost of trucks changes over time. Thus if the firm can rent capital for short periods of time, it calculates the cost of this capital in the same way that it calculates the cost of nondurable inputs such as labor services or materials. The firm faces a more complex problem in determining the OC of the truck if they purchase it. The firms accountant may expense the trucks purchase price by treating the full $20,000 as a cost at the time that the truck is purchased. Another option is the accountant may amortize the cost by spreading the $20,000 over the life of the truck, following rules set by an accounting organization by a relevant government authority such as the IRS
The true opportunity cost of using a truck that a firm owns is the amount that the firm......
Could earn if it rented truck to others
A past expenditure that cannot be recovered
Very easily observed unlike opportunity cost
Not relevant to a firm when deciding how much to produce now
If an expenditure is sunk.....
It is not an opportunity cost
If a firm buys a forklift for $25,000 and can resell it for the same price......
It is not a sunk cost and the OC of the forklift is $25,000
If a firm buys a forklift for $25,000 and cannot resell it......
The original expenditure is a sunk cost
Because a firm cannot vary some of its inputs in the short run, and as a result......
It is usually more costly for a firm to increase output in the short run than in the long run, when all inputs can be varied
Fixed costs (F)
A production expense that does not vary with output
Includes costs of inputs that the firm cannot practically adjust in the short run like land, a plant, large machines, etc.
The fixed cost for a capital good a firm owns and uses is the ........
Opportunity cost of not renting it to someone else
Variable cost (VC)
A production expense that changes with the quantity of output produced
The cost of the inputs the firm can adjust to alter it output level, such as labor and materials
Total cost (C)
The cum of a firms variable cost and fixed cost
C = VC + F
The amount by which a firms cost changes if the firm produces one more unit of output
MC = Change in cost (C)/Change in output (q)
Because only variable cost changes with output, we can also define this as
MC = change in variable cost (VC)/ change in output (q)
A firm uses marginal cost in deciding whether .......
It pays to change its output level
Three average cost measures used by firms
Average fixed cost (AFC)
Average variable cost (AVC)
Average Cost (AC)
Average fixed cost (AFC)
The fixed cost divided by the units of output produced
AVC = F/q
The fixed cost falls as output rises because the fixed cost is spread over more units
Average variable cost (AVC)
The variable cost divided by the units of output produced
AVC = VC/q
Because the variable cost increases with output, the AVC may either increase or decrease as output rises
Firms use this measure to determine whether to shutdown operations when demand is low
Average cost (AC)
The total cost divided by the units of output produced
AC = C/q
Also called the average total cost
This equals the sum of the average fixed cost and average variable cost
AC = AFC + AVC
A firm makes a profit if its average cost is below its price, which is the firms average revenue
The marginal cost curve (MC), cuts the ........
Average variable cost (AVC) and the average cost (AC) at their minimums
Where the MC curve is below the AC curve......
The average cost curve declines with output
The production function determines the shape of......
A firms cost curves
The production function shows.......
The amount of inputs needed to produce a given level of output
A firm calculates its cost by multiplying the quantity of each input by.....
Its price and summing the cost of the inputs
In the short run, when a firms capital is fixed, the only way a firm can increase output is to......
Use more labor
Diminishing marginal returns to labor
If a firm increases labor enough they will reach this point, at which, each extra worker increase output by a smaller amount. We can use this information about the relationship between labor and output (the production function) to determine the shape of the variable cost curve and its related curves
If input prices are constant.....
The production function determines the shape of the variable cost curve
Because the production function determines the shape of the variable cost curve, it also......
Determines the shape of the marginal, average variable, and average cost curves
When making decisions, managers rely more on .......
These per-unit cost measures (MC, AVC, AC) than on total variable cost
The extra labor required to produce one more unit of output equals.....
Change in Labor (L)/Change in output (q)
The marginal cost equals
The wage times the extra labor necessary to produce one more unit of output
How do we know how much labor we need to produce one more unit of output?
That information comes from the production function
The equation for MC shows that the marginal cost move in the opposite direction of ......
Marginal product of labor. At low labor levels, the marginal product of labor commonly rises with additional labor because extra workers help the original workers and make better use of equipment
Diminishing marginal returns to labor determine the shape of which curves?
The variable cost curve
The average variable cost curve
With a constant wage, the average variable cost moves in the opposite direction of the .......
Average product of labor
The average product of labor tends to rise and then fall so the average cost tend to....
Fall then rise
At low levels of output, adding strictly falling average fixed cost makes the average cost.......
Fall more steeply than the average variable cost curve
At high output levels, the average cost and average variable cost curves differ by......
Even smaller amounts as the average fixed cost (F/q) approaches zero
Taxes applied to a firm shift some or all of the......
Marginal and average cost curves
What would happen if the government collected a specific tax of $10 per unit of output from a firm?
This tax, which varies with output, affects the firms variable cost but not its fixed cost. As a result, it affects the firms average cost, average variable cost, and marginal cost, but not fixed costs. So at every quantity, the AVC, AC, and MC would rise by the full amount of the tax
Tax on every unit of output from a firm
Also called a business license fee
A lump sum that a firm pays for the right to operate a business
Ex: A four year license to sell hot dogs from a cart outside Yankee stadium cost $1.39 million. These taxes do not vary with output so they affect firms fixed costs only, not variable costs
The three cost level curves
The four cost-per-unit curves
Average cost (AC)
Average fixed cost (AFC)
Average variable cost (AVC)
Marginal cost (MC)
In the short run, the cost associated with inputs that cannot be adjusted is.......
The cost from input that can be adjusted is .....
Given that input prices are constant, the shapes of the variable cost and costs curve are determined by.......
The production function
Where a variable exhibits diminishing marginal returns, the variable costs and costs curves become relatively.......
Steep as output increases, so the AC, AVC, and MC curves rise with output
Because of the relationship between a marginal and an average, bot the average cost and average variable cost curves fall when........
The marginal cost curve cuts bot theses average cost curves at their minimum points
Although firms may incur fixed costs in the long run, these fixed costs are.......
Avoidable rather than sunk in the short termq
Firms in the long run are only worried about......
Total cost, average cost, and marginal cost and not all seven cost concepts that it considers in the short run
Firms in the long choose how much.......
Labor and Capital to use as apposed to just Labor in the short run. As a consequence of this the firms long run cost is lower than its short run cost of production if it has to use the "wrong" level of capital in the short run
A firm can produce a given level of output using many different.........
Technologically efficient combinations of inputs, as summarized by an isoquant
A firm want to choose the particular bundle of labor and capital with the lowest cost of production which is the.....
Economically efficient combination of inputs
All the combinations of inputs that require the same (iso) total expenditure (cost)
Equation for the cost of producing a given level of output in the long run on a isocost line
C = wL + rK
C = output
w = wage
L = labor
r = rental rate per hour
K = capital
Three properties of ascots lines
Where the ascots lines hit the capital and labor axes depends on the firms cost (C with a line over it) and on the input prices
Isocosts that are farther out from the origin have higher costs than those close to the origin
The slope of each ascots line is the same (-w/r)
Important difference between isocost and budget lines
The consumer has a single budget line determined by their income and firms face many isocost lines all representing different levels of expenditure the firm may take
Three equivalent approaches a firm can choose to minimize its costs
Lowest isocost rule
Last dollar rule
Lowest isocosts rule
Pick the bundle of inputs where the lowest isocost line touches the isoquant
Pick the bundle of inputs where the isoquant is tangent to the isocost line
Last dollar rule
Pick the bundle of inputs where the last dollar spend on one input give as much extra output as the last dollar spent on any other input
If an isocost line crosses the isoquant twice......
Another lower isocost must also touch the isoquant
Slope of an isoquant is......
The marginal rate of technical substitution (MRTS)
Once a firm determines the lowest cost combination of inputs to produce a given level of output.......
It uses that method as long as the input prices remain constant
A change in the relative price of inputs affects the.......
Mix of inputs a firm uses
The cost minimizing combination of labor and capital for each output level
The shapes of the average cost and marginal cost curve depend on the.......
Shape of the long run cost curve
Why does the long run average cost curve first fall and then rise?
In the long run returns to scale play a major role in determine the shape of the average cost curve and most other cost curves. Increasing all inputs in proportion may cause increasing, decreasing, or constant returns to scale so if a production function has this and prices of inputs are constant, a long run AC curve must be U shaped F
Economies of scale
Property of a cost function whereby the average cost of production falls as output expands
Diseconomies of scale
Property of a cost function whereby the average cost of production rises when output increases
A firms long run decisions such as choosing plant size determine its......
Short run costs
Because a firm cannot vary its capital in the short run but can vary it in the long run, short run cost is at least......
As high as long run cost and is higher if the wrong level of capital is used in the short run. As a result the long run average cost is always equal to or below the short run average cost
The total number of units of output produced since the product was introduced
The relationship between average costs and cumulative output
Economies of scope
Situation in which it is less expensive to produce goods jointly than separately
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