ECON chapter 6 and 7 Quiz
Terms in this set (75)
A cost that has been paid or can't be changed today. Should have no effect on making decisions about future outcomes.
Total Economic Costs
Involve two costs:
Explicit- involves actual payments paid to non- owners of the firm for resources that they provide to the firm. (accounting costs)
Implicit-may have no direct payment but represents the value of resources the owners of the firm provide (opportunity cost) Ex. Making his restaurant in a building he already owns
Formula for total economic costs
Explicit costs+ implicit costs= total economic costs
Factors of Production- Explicit or implicit costs
Profit- Implicit only
* Depends on who is providing the resources: the owners or non- owners
Implicit Cost of Raw materials
Owners time (labor income forgone)
Least -Cost Rule
A firm produces any given output level using the lowest cost combination of inputs available.
What does least-cost combination depend on?
1. Nature of the firms technology
2. Prices the firm must pay for its inputs
3. Time horizon for the firms planning
What are the two types of cost? (short run)
1. Total costs
2. Average and Marginal costs (per unit costs)
Costs of inputs that don't change as output changes
Ex. Plant size (capital)
Costs of inputs that vary as output changes
Ex. Labor (number of workers)
Total Cost Formula
Variable costs + Fixed costs
Cost in the short run
~Total Fixed Cost (TFC) - the cost of all inputs that are fixed in the short run (plant)
~Total Variable Cost (TVC)- the cost of all variable inputs used in producing a particular level of output (labor)
~Total Cost (TC)- the cost of all inputs, fixed and variable used to produce a given output level in the short run
Average Fixed Cost (AFC)
Total fixed cost divided by the quantity of output produced
Average Variable Cost (AVC)
Total variable cost divided by the quantity of output produced
AVC= TVC/ Q
Average Total Cost (ATC)
Total cost divided by the quantity of output produced
ATC= TC/Q OR
ATC= AFC+ AVC
Marginal Cost (MC)
The increase in total cost from producing one more unit of output.
It tells us how much cost rises per unit increase in output
MC= Change in TC/ Change in Q
AVC and ATC are both graphically what shape?
AFC is what distance on the graph?
The vertical distance between ATC and AVC, becomes smaller as output increases.
Also U shaped, reflecting first increasing and then diminishing marginal returns to labor. MC passes through the minimum points of both AVC and ATC curves.
What is the goal of the firm?
To maximize profit, because most firms do want this we will assume this to be true.
How do you find profit?
total revenue- total economic cost
What is production?
Process of combining inputs to make goods and services
What is the production function?
The maximum output a firm can produce with given inputs.
Factors of production (land, labor, capital, and entrepreneurship) plus raw materials.
Long Run inputs
all inputs are variable
short run inputs
at least one of the firms inputs cannot be changed in quantity.
An input whose quantity can change over some time period
An input whose quantity must remain constant over some time period.
Ex) capital is a fixed input in the short run
The maximum quantity that of output that can be produced from a given combination of inputs.
Total Product represented graphically
the total product curve-
horizontal axis: number of workers
Vertical axis: total product (quantity)
Total product rises as each worker is added to production up to a certain point
Marginal Product of Labor
MPL= Change in Q/ Change in L (labor)
-the additional output produced when one or more workers are hired
Law of diminishing (marginal) returns
As we continue to add more of any one input, holding the other input constant, its marginal product will eventually decline.
Why do diminishing marginal returns exist?
Because we are adding more and more workers to a fixed input: the factory.
-factory size (capital) is fixed in the short run
- there is not enough time to build a new factory
What affects profits?
total revenues and total costs
Input that cannot be changed gradually as the firm size increases, but must instead be adjusted in large jumps
Long Run average total costs
decrease as plant size increases
-rises proportionately less than output
how does the LRATC curve slope?
Causes for economies of scale?
1. Gains from specialization
2. Spreading costs of lumpy inputs
3. Lower costs of capital
Long Run Average Total Cost
Cost per unit of producing each quantity of output, in the long run, when all inputs are variable.
LRATC= LRTC/ Q
Relationship between long run and short run costs
LRTC greater than or equal to TC
LRATC less than or equal to ATC
In the long run (inputs and costs)
There are no fixed inputs or costs, all inputs and costs are variable.
Long run output production
firms use least cost rule
Long Run Total Cost (LRTC)
Cost of producing each quantity of output when all inputs are variable and the least cost input mix is chosen.
Short Run ATC curve
Represents the average costs when plant size is fixed.
Can a firms plant be changed in the long run?
Yes, the firm will operate on a new ATC curve that reflects the costs of the larger plant.
Long run ATC curve
Combines portions of each ATC curve available to the firm in the long run.
-For each output level, the firm will always choose to operate on theATC curve with the lowest possible cost.
In the short run...
A firm can only move along its current ATC curve.
In the long run...
A firm can move from one ATC curve to another
-by varying the size of its plant
-moving along its LRATC curve
Combines portions of all the firms ATC curves for each level of output
As plant size increases, long run average costs:
- first decline (economies of scale)
- then remain constant (constant returns to scale)
- and finally rise (diseconomies of scale)
It is not just about increasing output!
- we can increase output in the short run without seeing economies or dis economies of scale.
Economies of Scale
Long run average total cost decreases as plant size increases
-LRATC curve slopes downward
-long run total cost rises proportionately less than output
Diseconomies of Scale
Long Run total cost increases as firm size increases
-LRATC curve slopes upward
-Long run total cost rises more than in proportion to output.
Why does total cost rise more than in proportion to output?
1. Communication Problems
2. Loss of morale
3. Management Challenges
Constant returns to scale
Long -run average total cost is unchanged as firm size increases
-LRATC curve is flat and at its lowest point
-Both output and long -run total cost rise by the same proportion
What is the minimum efficient scale?
The lowest output level at which the LRATC hits bottom is the firms minimum efficient scale.
What does the MES tell us?
How large a firm must grow in order to fully exploit economies of scale
Firms that grow their MES...
have a cost advantage over other firms that operate at smaller output levels.
Example of how ATC and MC are related graphically...
Your course average (average score) and your next exam grade (marginal score)
-when your next exam grade is below your course average it brings your average down
-when your next exam grade is above your average it brings your average up
- When MC is below ATC, it is pulling ATC down
-when MC is above ATC, it is pulling ATC up
-- Therefore, MC crosses ATC at its minimum
AVC curve graphically
The AVC curve is also U shaped
-when MC curve is below AVC, AVC is falling
-when MC is above AVC, AVC is rising
-- MC crosses both the AVC curve and the ATC curve at their respective minimum points
Shows the maximum amount of two goods a consumer could afford with a limited budget at given (constant) prices
-graphically represented with a budget line
-critical assumptions: Budget and prices are fixed
The budget constraint example...
If Py: price of good on vertical axis
Px: price of good on horizontal axis
Then, Py/Px is
-The relative price of good X
-the opportunity cost of one more unit of good x in terms of the number of y given up
-The absolute slope of the consumers budget line
An Increase or Decrease in budget:
increase- shifts budget line outward
decrease- shifts budget line inward
These shifts are parallel
--Changes in budget do not change the budget lines slope because prices did not change
Changes in price of one good
if good Y decreases in price then the budget line rotates up y axis as slope changes because relative prices change
-the X intercept does not change
Rational Preferences must satisfy two conditions:
1. Any two alternatives can be compared, and one is preferred or else the two are valued equally.
2. The comparisons are logically consistent or transitive (If A is better than B and B is better than C, then A is better than C)
-MORE IS BETTER
-- always prefer a point on the budget line rather than a point below it
Total Utility (TU)
Quantitative measure of pleasure/ satisfaction obtained from consuming a given amount of a good or service
Marginal Utility (MU)
Change in satisfaction received from consuming one more unit of a good or service.
- Change in TU/ Change in Quantity= MU
Law of diminishing marginal utility
as consumption of a good or service increases, marginal utility decreases
Marginal utility graphically can be...
zero when TU is not changing, the slope of TU is flat, or TU is at a maximum
-can be negative when TU is decreasing
Consumers will never choose more than when TU is max or MU is 0
-if they go beyond this point then that creates "disutility"
Consumer will choose the quantities on the budget line such that the marginal utility per dollar is the same for both goods:
Max/ Px= MUy/ Py
-There is no higher level of satisfaction from reallocating expenditures in either direction
Consumer has achieved consumer equilibrium by choosing the two quantities that give the highest overall level of satisfaction
MU per dollar spent
Pizza = $2
Coke- 15 utils/ $1= 15
Pizza- 6 utils/ $2= 3
-15 is greater than 3 so the consumer gets more satisfaction from the last dollar spent on coke than on pizza.
Because of this...
Since the last dollar spent on coke gave more satisfaction than pizza, he should consume more coke and fewer slices of pizza.
If the consumer enjoys the last dollar spent on each good the same amount...
MUx/ Price X= MUy/ Price Y= MUz/ Price z
-there is only one combination on the budget constraint that will satisfy this requirement