L11 - Short-Run Production and Costs

Question 1

What factors are variable in the short run?

Answer 1

only one factor of production is variable others are fixed

Question 2

What factors are variable in the long-run?

Answer 2

all factors of production are variable

Question 3

What is the underlying assumption of each firm?

Answer 3

each firms objective is to maximise profit

Question 4

How do you calculate profit?

Answer 4

Profit (π)=Total Revenue(TR) - Total cost (TC)

Question 5

How do you calculate total revenue?

Answer 5

Total revenue = price x quantity

Question 6

What does a firm need consider in its costs?

Answer 6

• the cost of something is what you give up to receive it.
• A firm’s costs include opportunity costs –> this is so a firm can make better decision by considering what they may lose out on
• this is specific to economic costs

Question 7

What are the two types of costs and how do Accounting Profit differ from Economic Profits?

Answer 7

• Explicit costs: require a cash flow from the firm
• Implicit costs: do not require a cash to flow out of the firm –> running a business is costly - owner could do something else with time and money

Difference between accounting and economic profit

• Accounting profit = total revenue – explicit costs
• Economic profit = total revenue – explicit costs – implicit costs

Question 8

What is a the short-run production function?

Answer 8

• A production function states how total output changes with labour (L) and capital (K)
• In the short run labour is variable and capital fixed. A short-term production
  function states how total output changes with labour (L) for a given level of
  capital (K).

Question 9

What is Total physical product of labour (TPP{L})?

Answer 9

This is total output that is produced by the units of labour, for a given capital

Question 10

What is the Average physical product of labour (APP{L})?

Answer 10

This is the average output produced by the units of labour, for a given capital:
- APP{L}=TPP{L}/L

Question 11

What is the Marginal physical product of labour (MPP{L})?

Answer 11

This is the extra output of producing one more unit of labour, for a given capital:
- MPP{L}=ΔTPP{L}/ΔL
OR
- MPP{L}=TPP{L+1} - TPP{L}

Question 12

What is the Law of Diminishing Returns?

Answer 12

• When some factors are fixed in the short run, employing another unit of a
  variable factor eventually results in smaller and smaller increases in output
  -This means to increase production larger amounts of variable factors must be
  used. Why is diminishing returns inevitable?
  -When number of tractors fixed, can only
  increase output by increasing workers.
  But sooner or later, the workers will just
  get in each other’s way
• Short run production in subject to diminishing returns

Question 13

How would you plot Total Physical Product on a graph?

Answer 13

• With number of product on the y-axis and units of labour employed on the x-axis
• at the top when dy/dx = 0 is the maximum output

Question 14

How would you plot Marginal Physical Product on a graph?

Answer 14

• taking the TPP graph
• you look at the change in TPP against the change in L
• you then plot the change on a separate graph ( on the x-axis you would plot it inbetween the value of change e.g. change from 1 worker to 2 then plot at 1.5
• when dy/dx=0 –> show where diminishing returns sets in
• when the MPP curve cross the x-axis –> where maximum output occurs

Question 15

How would you plot Average Physical Product on a graph?

Answer 15

• by taking each value of TPP and simply dividing it be the value of Labour it corresponds with and plotting those points

Question 16

How do you calculate total costs?

Answer 16

A firm’s total cost function reflects its production function
- Total costs (TC) = total fixed costs (TFC) + total variable costs (TVC)

Total fixed(economic) costs (TFC)

• Fixed costs are not related to the amount of output produced
• They are incurred even if nothing is produced
• They can change but not as a result of increasing output
• These relate to “costs for tractors etc” in our previous example

Total variable (economic) costs (TVC)

• Variable costs are related to the amount of output produced
• They are not incurred if nothing is produced
• They increase as more is produced
• These relate to “costs of workers” in our previous example

Question 17

How do you calculate Average Total Cost?

Answer 17

1. How much does it cost to make a unit of output on average?
   Average total costs (ATC) = average variable cost (AVC)
   + average fixed cost (AFC)

This is the average cost per unit of output:
ATC = TC/Q
= (TVC + TFC)/Q
= TVC/Q + TFC/Q
= AVC + AFC

Question 18

How do you calculate Marginal Costs?

Answer 18

How much does it cost to produce an extra unit of output?
Marginal costs (MC)
- This is the extra cost of producing one more unit of output
MC = ∆TC/∆Q
= TC{Q+1} –TC{Q)}

Question 19

What do the Average and Marginal Cost curves look like on a graph?

Answer 19

• With Costs(£) on the y-axis and Output (Q) on the x-axis
• the MC curve is the steepest out of all of them and rises much quicker –.> it start by falling and then start rising
• The Average Variable Cost and Average Total Cost have a similar shape (the ATC is more circle and round in its shape) with the Average Variable cost being slightly shifted down for the ATC curve –> both fall and rise like the MC curve

Question 20

What does the Marginal Cost curve tell us?

Answer 20

• Falling MC = increasing returns

- Rising MC = diminishing returns

Question 21

What does the Average Cost curve tell us?

Answer 21

• When marginal cost is below average cost then average cost is falling
• When marginal cost is above average cost, then average cost is rising
• The bottom of the average total cost curve is the minimum efficient scale

Question 22

What is the minimum efficient scale?

Answer 22

Minimum efficient scale corresponds to the lowest point on the long run average cost curve and is also known as an output range over which a business achieves productive efficiency.
- MES is not a single output level – more likely, the MES is a range of outputs where the firm achieves constant returns to scale and has reached the lowest feasible cost per unit.