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Chapter 5: The Production Process and Costs
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Terms in this set (48)
K
denotes the quantity of capital
Q
the level of output produced in the production process
production function
a function that defines the maximum amount of output that can be produced with given set of inputs
Q = F(K,L)
production function
short-run
the time frame in which there are fixed factors of productions
less than three years
variable factors
are the inputs a manager can adjust to alter production
fixed factors
are the inputs the manager cannot adjust in the short run
long run
as the horizon over which the manager can adjust all factors of production
more that three years
total product (TP)
the maximum level of output that can be produced with a given amount of inputs
average product (AP)
a measure of the output produced per unit of input
marginal product (MP)
the change in total output attributable to the last unit of an input
increasing marginal returns
range of input usage over which marginal product increases
decreasing (diminishing) marginal returns
range of input usage over which marginal product declines
negative marginal returns
range of input usage over which marginal product is negative
value marginal product (VMP)
the value of the output produced by the last unit of an input
profit-maximizing input usage
the demand for an input by a profit-maximizing firm.
linear production function
a production function that assumes a perfect linear relationship between all inputs and total output
Leontief production function
a production function that assumes that inputs are used in fixed proportions
also called FIXED-PROPORTIONS PRODUCTION FUNCTION
Leontief production function is given by
Q = F(K,L) = min {aK,bL}
linear production function is given by
Q = F(K,L) = aK +bL
Cobb-Douglas production function
a production function that assumes some degree of substitutability among inputs
Cobb-Douglas production function is given by
Q = F(K,L) = K^aL^b
isoquant
defines the combinations of inputs that yield the same level of output
marginal rate of technical substitution (MRTS)
the rate at which a producer can substitute between two inputs (K and L) and maintain the same level of output
L shaped isoquants
produced by Leontief production function
law of diminishing marginal rate of technical substitution
a property of a production function stating that as less of one input is used, increasing amounts of another input must be employed to produce the same level of output
isocost line
a line that represents the combinations of inputs that will cost the producer the same amount of money
cost minimization
producing output at the lowest possible cost
optimal input substitution
to minimize the cost of producing a given level of output, the firm should use less of an input and more of other inputs when that input's price rises
cost function
the C in C(Q)
-Extremely valuable because it provides essential information a manager needs to determine the profit
-Maximizing level of output.
summarizes information about the production process. -Reduces the amount of information the manager has to process to make optimal output decision.
total cost
sum of fixed and variable costs
fixed costs
costs that do not change with changes in output; include the costs of fixed inputs used in production
variable costs
costs that change with changes in output; include the costs of inputs that vary with output
short-run cost function
a function that defines the minimum possible cost of producing each output level when variable factors are employed in the cost-minimizing fashion
average fixed cost
fixed costs divided by the number of units of output
average variable cost (AVC)
variable costs divided by the number of units of output
Average total cost (ATC)
defined as total cost (TC) divided by the number of units of output
marginal (incremental) cost (MC)
the cost of producing an additional unit of output
sunk cost
a cost that is forever lost after it has been paid
irrelevance of sunk costs
a decision maker should ignore sunk costs to maximize profits or minimize losses
cubic cost function
costs are a cubic function of output; provides a reasonable approximation to virtually any cost function
long-run average cost curve
a curve that defines the minimum average cost of pro ducting alternative levels of output, allowing for optimal selection of both fixed and variable factors of production
economies of scale
exist when long-run average costs decline as output is increased
diseconomies of scale
exist when long-run average costs rise as output is increased
constant returns to scale
exist when long-run average costs remain constant as output is increased
multi product cost function
a function that defines the cost of producing given levels of two or more types of outputs assuming all inputs are used efficiently
economies of scope
when the total cost of producing two types of outputs together is less than the total cost of producing each type of output separately
cost complementarity
when the marginal cost of producing one type of output decreases when the output of another good is increased
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