ec 5 study guide 2

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Tufts University
Kelly Greenhill

Technology, Production, and Costs Technology- the processes a firm uses to turn inputs into outputs of goods and services Technological change- a change in the ability of a firm to produce a given level of output with a given quantity of inputs Basic activity of a firm: use inputs (workers, machines, natural resources) to produce outputs (goods and services. Short run- the period of time during which at least one of a firm’s inputs is fixed (some limitation) Long run- the period of time in which a firm can vary all its inputs, adopt new technology and increase or decrease the size of its physical plant (everything’s a variable) Total cost- the cost of all inputs a firm uses in production • Total Cost = Fixed Cost + Variable Cost • TC = FC + VC Variable costs- costs that change as output changes Fixed costs- costs that remain constant as output changes Opportunity cost- the highest-valued alternative that must be given up to engage in an activity Explicit cost- a cost that involves spending money (sometimes called accounting costs) Implicit cost- a nonmonetary opportunity cost Economic costs- include both accounting and implicit costs Economic depreciation- the difference between the amount paid for capital at the beginning of the year and the amount it could be sold for at the end of the year Production function- the relationship between the inputs employed by a firm and the maximum output it can produce with those inputs Average total cost- total cost divided by the quantity of output produced Marginal product of labor- the additional output a firm produces as a result of hiring one more worker • goes down as number of workers goes up Law of diminishing returns- the principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline • due to division of labor and specialization of worker • rises initially because of the effects of specialization and division of labor, and then it falls due to the effects of diminishing returns. Average product of labor- the total output produced by a firm divided by the quantity of workers • average of the marginal products of labor • (marginal output)/(# of workers) Marginal cost- the change in a firm’s total cost from producing one more unit of a good or service • MC=ΔTC/ ΔQ • equals average total cost at the minimum of average total cost  When the marginal product of labor is rising, the marginal cost output is falling.  When the marginal product of labor is falling, the marginal cost of production is rising. Average fixed cost- fixed cost divided by the quantity of output produced Average variable cost- variable cost divided by the quantity of out produced with Q being the level of output Average total cost = ATC = TC Q FC ATC = AFC +AVC Average fixed cost = AFC = Q VC Average variable cost = AVC = Q Graphically speaking: • distance between atc and avc = average fixed cost • avc and atc at minimum when crossing mc Keep in mind… 1) When marginal cost is less than average variable cost or average total cost, it causes them to decrease. When it is greater, it causes them to increase. Therefore, when they are equal, they must be at their minimum points where the marginal cost curve intersects.All three of these curves are U shaped. 2) Average fixed cost gets smaller and smaller as output increases because in calculating average fixed cost, we are dividing something that gets larger and larger—output—into something that remains constant—fixed cost. Firms often refer to this process of lowering average fixed cost y selling more output as “spreading the overhead” (referring to fixed costs). 3) The difference decreases between average total cost and average variable cost because it is representing average fixed cost, which gets smaller as output increases. Long-run average cost curve- a curve that shows the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed • long-run average cost is the lower envelope of the short-run average cost curves Economics of sale- the situation when a firm’s long-run average costs fail as it increases the quantity of output it produces Constant returns to scale- the situation in which a firm’s long-run average costs remain unchanged as it increases output Minimum efficient scale- the level of output at which all economies of scale are exhausted Diseconomies of scale- the situation in which a firm’s long-run average costs rise as the firm increases output  Diminishing returns applies only to the short run, when at least one of the firm’s inputs, such as the quantity of machinery it uses, is fixed. Term Definition Symbols/Equations Total Cost The cost of all the inputs used by a firm, or fixed cTCt plus variable cost Fixed Costs Costs that remain constant as a firm’s level of outpuFC changes Variable Costs Costs that change as the firm’s level of output changVC Marginal Cost Increase in total cost resulting from producing anothMC=ΔTC /ΔQ unit of output Average Total Cost Total cost divided by the quantity of output producedATC = TC/Q Average Fixed Cost Fixed cost divided by the quantity of output producedAFC= FC/Q Average Variable Cost Variable cost divided by the quantity of output produAVC= VC/Q Implicit Cost Anonmonetary opportunity cost Explicit Cost Acost that involves spending money  Diseconomies of scale apply only to the long run, when the firm is free to vary all its inputs, can adopt new technology, and can vary the amount of machinery it uses and the size of its facility Perfectly Competitive Markets Market Structure # of firms Type of product Ease of entry Examples Perfect Competition Many Identical High • wheat • apples Monopolistic Many Differentiated High • clothing Competition • restaurants Oligopoly Few Identical or differentiatedLow • cars • computers Monopoly One Unique Entry blocked • tap water • mail Firms in perfectly competitive industries are unable to control the prices of the products they sell and are unable to earn economic profit in the long run because 1. firms in these industries sell identical products 2. it is easy for new firms to enter these industries Most industries are not perfectly competitive Perfectly competitive market- a market that meets the conditions of: 1. many buyers and sellers 2. all firms selling identical products 3. no barriers to new firms entering the market A perfectly competitive firm cannot affect the market price. Market price is determined by the intersection of market demand and market supply curve (equilibrium). Price taker- a buyer or seller that is unable to affect the market price Aperfectly competitive firm (i.e. that single firm) faces a horizontal demand curve because it is assumed that its products are the exact same/substitutes for other firms’products and it has to sell at the market price (not one cent below or above, otherwise, it will lose buyers). Profit- total revenue minus total cost • Profit = TR – TC Average Revenue (AR)- total revenue divided by the quantity of the product sold • AR = TR/Q • TR = P x Q • AR = TR/Q = PQ/Q = P Marginal Revenue- the change in total revenue from selling one more unit of a product • MR =ΔTR/ΔQ • MR curve is the same as the demand curve (only firm where this occurs) In perfect competition a firm can sell each additional unit at the market price P. So in perfect competition, both average and marginal revenue is the market price P: MR =AR = P. (only true with perfect competition) Profit increases as output increases so long as MR>MC, but profit decreases as output increases so long as MRATC, firm makes profit • P =ATC, firm breaks even • P
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