1.5 Theory of the firm Flashcards
What does short run mean?
A time period during which at least one input (one factor/cost of production) is fixed and cannot be changed.
What is the long run?
A time period during which all inputs (all factors/costs of production) are variable and can be changed.
Define: TP
Total Product: the total quantity of output produced by a firm.
Define: MP
Equation?
Marginal Product: The additional output resulting from one additional unit of variable input e.g. labour.
The rate of change of Total Product.
MP = ΔTP / Δunits of input
Define: AP
Equation?
Average Product: the total quantity of output per unit of variable input e.g. labour.
AP = TP / units of input
How would you diagrammatically present:
a) TP
b) MP
c) AP
a) a positive correlation line to a maximum point, where it curves and starts to decrease
b) a line that starts very positive, then curves quickly and starts to decrease into the negatives (when TP starts to decrease)
c) a shallow curve that is maximum when AP=MP, after which slowly decreases
What is the law of diminishing returns?
AKA: Law of diminishing marginal product.
As more and more units of variable input (e.g. labour) are added to one or more fixed inputs (e.g. land), the marginal product of the variable input first increases, but then comes a point when it starts to decrease.
What are explicit costs?
Examples?
Payments made by a firm to outsiders to acquire resources for use in production. These are usually financial costs.
Such as resources, rent, wages, menu costs.
What are implicit costs?
Examples?
The sacrificed income arising from the use of self-owned resources by a firm. Usually opportunity costs.
E.g. opportunity costs of foregone income, entrepreneurial talent, land which could’ve been rented out.
What is the difference between accounting profit and economic profit?
Accounting profit = revenue - explicit costs. Like a balance sheet.
Economic profit = revenue - (explicit and implicit costs). Like a business decision sheet.
Which will always be lower: economic profit or accounting profit?
What does this mean?
Economic profit will always be lower as economic costs will always be greater than explicit (accounting costs).
This means that despite a firm is making an economic loss, it could still be making accounting (financial) profit.
What does an economic loss mean?
What does an accounting loss mean?
Economic loss indicates that the way that a firm is being run is illogical, despite it making money. E.g. you could be making more money if you were employed by a different firm.
Accounting loss indicates that the firm is losing money.
What are fixed costs?
Examples?
Costs that do not change as output changes, arising from fixed inputs.
E.g. rental payments, interest on loans, insurance, salaries.
What are variable costs?
Examples?
Costs that vary (change) as output changes, arising from the use of variable inputs.
Define: TC
Define: TVC
Define: TFC
Total Costs: the sum of fixed and variable costs.
Total Variable Costs: the sum of all variable costs.
Total Fixed Costs: the sum of all fixed costs.
Define: AC (ATC)
Define: AVC
Define: AFC
Equations?
Average (Total) Costs: (Total) costs per unit of output.
Average Variable Costs: Variable costs per unit of output.
Average Fixed Costs: Fixed costs per unit of output.
ATC = TC / Q | AVC = TVC / Q | AFC = TFC / Q
Define: MC
Equations?
Marginal Cost: is the additional cost of producing one more unit of output.
MC = ΔTC/ΔQ = ΔTVC/ΔQ
How would you diagrammatically show:
a) TC
b) TVC
c) TFC
a) A curve that starts at TFC at Q=0, which goes up, flattens, and then curves up again.
b) The same shape of TC but starts at 0 when Q=0.
c) A horizontal line at TFC for all quantities.
How would you diagrammatically show:
a) MC
b) AFC
c) AVC
d) ATC
a) A curve that goes downwards, turns, and then goes up again.
b) Like a 1/x function, just keeps decreasing but by less each time.
c) A shallow U-shaped curve with a minimum when MC = AVC
d) An L-shaped curve with a minimum when MC = ATC
