Chapter 9A: Short Run

Question 1

What is the goal of the firm

Answer 1

If a firm is not profitable, it cannot continue to exist in the long run therefore the goal of the firm is profit maximisation

Question 2

Basic concepts

Answer 2

Total
- Sum of

Average
- Total divided by Qty

Marginal
- Change in total
- Per extra or additional unit

Question 3

Explain short run

Answer 3

• At least one of the inputs is fixed (e.g. capital, land)
• Has fixed plant capacity size
• A firm can only expand its output by increasing the quantity of the variable input (e.g. labour, raw materials)

Question 4

Explain long run

Answer 4

• All the inputs are variable
• Has a variable plant capacity size
• E.g. New factory

Question 5

Accounting Costs

Answer 5

This includes explicit costs
- Refers to money that companies, firms pay for factors of production and other inputs
- E.g. Explicit costs would be the amount that it cost you to go around selling your product the money you spend on advertising and wedges

Question 6

Economic Cost

Answer 6

This is more comprehensive
- Includes both explicit and implicit costs
- Implicit costs are opportunity costs that are not reflected in monetary payments
- Implicit costs would include the value of whatever else you could’ve been doing with your time instead, salary you could’ve been receiving had you gone to work instead of opening the business

Question 7

What is total profit (accounting profit)

Answer 7

TR - Explicit costs
TR > Explicit costs

Question 8

What is normal profit

Answer 8

• Minimum profit that is just covering the firms cost
• TR = TEC

Question 9

What is economic profit

Answer 9

TR - TEC (Implicit + Explicit)
TR > TEC
If TR < TEC The firm is making a negative economic profit/loss

Question 10

What is abnormal/excess/supernormal profit

Answer 10

Profit > Implicit + Explicit

Question 11

What is production

Answer 11

Production is the physical transformation of inputs into outputs

The main goal is to maximise profit by maximising the positive difference between TR and TC

Question 12

What are the assumptions for analysing production in the short run

Answer 12

• 1 product
• Homogeneous, devisable
• Inputs can be divided and can be used in limitless quantities
• Fixed production function, price, inputs and variable input

Question 13

What is the production function (PF)

Answer 13

Relationship between the inputs of a firm and their output at a given period of time, ceteris paribus

In short, relationship between input and output of the firm

Question 14

What does the production function depend on

Answer 14

It depends on the state of technology, when technology changes, the PF changes.

For instance, introducing a new technique in production can enable a firm to combine inputs differently and obtain a higher level of output with the same amount of input

Question 15

What are the characteristics of inputs

Answer 15

Fixed: This means that the level of usage cannot be changed.
Land, capital

Variable: Level of usage can be changed.
Labour services, raw materials

Question 16

When analysing the short run, one input must be fixed.
True or False

Answer 16

True

Question 17

What is the law of diminishing marginal returns

Answer 17

States that when more of a variable input is combined with one or more fixed inputs in a production process, points will eventually be reached with first the marginal product, then the average product and finally the total product start to decline

Question 18

Further explain the law of diminishing marginal returns

Answer 18

The average product of the variable input = TP/N
The marginal product of the variable input = changes in TP/changes in N

Question 19

Relationship between average and marginal product of labour

Answer 19

Average product increases if marginal product is above it, it reaches a maximum where it is equal to marginal product and then decreases when marginal product is below it

Question 20

Explain the relationship between the total product of labour and marginal product of labour

Answer 20

Total product increases as long as marginal product is positive, but once marginal product becomes negative total product decreases

Question 21

Name and explain the short run production costs

Answer 21

Fixed cost - Cost that remains constant irrespective of the quantity of output produced. Also called overheads e.g. rent (land)

Variable cost - cost the changes when total product changes. Also called direct costs e.g. labour costs

Total cost = Total fixed cost + total variable cost

Average cost = Average fixed cost + average variable cost

Marginal cost = The increase in total cost when one additional unit of output is produced