Week 2 - Production + Cost Functions

Question 1

What are the steps of describing a firm’s behaviour?

Answer 1

1) Examine short and long run production processes
2) Analyse relationship between inputs and outputs - production function
3) Examine output cost relationship in short and long run

Question 2

What is a firm?

Answer 2

An organisation that employs factors of production to produce goods and services

Question 3

General Equation for Production Function

Answer 3

Y = Q = A * F(K, L) where:
Q = Quantity/Output, K = Capital, L = Labour, A = Technology Level
(Place a bar on top for fixed values)

Question 4

What is the goal of a firm?

Answer 4

To maximise profit, recalling the constrained maximisation problem

Question 5

What is the Short Run?

Answer 5

Time frame where at least one of the factors of production is fixed (A and K are likely to be fixed and L is viable)

Question 6

What is the Long Run?

Answer 6

The time frame in which all input factors are variable

Question 7

Difference between a short and long run

Answer 7

How long it takes for a firm’s inputs to become available

Question 8

How is Total Production of Labour depicted?

Answer 8

By a graph

Question 9

Impact of small amount of labour for the short run?

Answer 9

output increases very fast = increasing returns, because more of increased specialisations

Question 10

Impact of medium-high amounts of labour for short run?

Answer 10

Output increases but slower, because of law of diminishing returns. Fixed capital technology, at some point addition of labour means each worker has less fixed capital to work with

Question 11

Impact of very large amounts of labour for short run

Answer 11

Output decreases because of the law of diminishing returns

Question 12

Equation for Average Product of Labour

Answer 12

APL = Q/L
- Average output each worker can produce

Question 13

Equation for Marginal Product of Labour

Answer 13

MPL = Change in Q/Change in L = Derivative of Q w/ respect to L
- The production function slope (0 gives maximum output)

Question 14

Trends of TPL for short run

Answer 14

1) MPL cuts through APL at maximum
2) When MPL > APL, average is increasing with L
3) When MPL < APL, average starts falling too with L

Question 15

What is the Law of Diminishing Returns?

Answer 15

As successive units of a variable source are added to a fixed resource, beyond some MP attributable to each additional unit of the variable resource will decline

Question 16

What is the LDR in the context of the TPL

Answer 16

There comes a point if we employ more labour, we probably can product more output, but output is going to increase at a decreasing rate

Question 17

What are we interested in for the long run?

Answer 17

How output quantity changes when there is a proportional change in the factors of production

Question 18

What are returns to scale for the long run?

Answer 18

Quantity of output changes when there is a proportional change in the quantity of all inputs

Question 19

Difference between returns to scale and LDR

Answer 19

Returns to scale is a LR phenomenon (inputs are variable) and LDR is a short run phenomenon (capital = fixed)

Question 20

What are constant returns to scale

Answer 20

Increase output by same proportional change (Double inputs = Double outputs)

Question 21

What are increasing returns to scale?

Answer 21

Output increases by more than proportional input change (double inputs = triple outputs)

Question 22

What are decreasing returns to scale?

Answer 22

If outputs increase by less than proportional input increase (triple inputs = double outputs)

Question 23

What does a firm’s cost function relate?

Answer 23

Total cost of population and output

Question 24

What type of relationship is there between production function and cost function?

Answer 24

One-to-one

Question 25

Firms aim to maximise profits where profit = ___

Answer 25

Economic Profit

Question 26

How do economic profits differ from accounting profits?

Answer 26

Accounting Profits = Revenue - Explicit Costs Economic Profits (pi)= Revenue - Total Opportunity Costs

Question 27

Economic Profits (pi) =

Answer 27

Total Revenue - Total Cost TR = Amount a firm received for output sale TC = Amount paid for production inputs + forgone opportunities (not including sunk)

Question 28

What is zero economic profit

Answer 28

When revenues just cover opportunity cost, i.e. Revenue = OC

Question 29

What is a cost function?

Answer 29

A function that links the quantity of output with its associated production cost, i.e. TC = f(q)

Question 30

Equation for TC in short run

Answer 30

TC = Total Fixed Costs + Total Variable Costs

Question 31

What are TFC

Answer 31

Total costs that do not vary with output changes

Question 32

What are TVC

Answer 32

Total costs that change with output level

Question 33

Effects of the TVC and TC Curve (Short Run)

Answer 33

1) Low output level = TVC and TC increase at decreasing rate because of production function and low output level 2) High output level = TVC and TC increase at increasing rate because more labour increases production

Question 34

Equation for Average Fixed Costs

Answer 34

AFC = TFC/Q

Question 35

Equation for Average Variable Costs

Answer 35

AVC = TVC/Q

Question 36

Equation for Average Total Costs

Answer 36

ATC = TC/Q or AFC + AVC

Question 37

Marginal Cost (for TVC and TC Short Run Curve)

Answer 37

MC: = Change in TC / Change in Q = dTC / dQ = dTVC / dQ

Question 38

Relationships between AFC, AVC, and MC:

Answer 38

1) AFC declines as Q increases (Q is denominator) 2) AVC declines, reaches min, then increases - U shape (LDR, VC increase) 3) MC declines sharply, reaches min, then increases- U shape (MPL rises then falls + LDR)

Question 39

Why does the MC cut both AVC and ATC @ minimums?

Answer 39

1) When MC > ATC, ATC increases 2) When MC < ATC, ATC decreases 3) When MC = ATC, ATC is at its minimum

Question 40

Why should LR costs < SR costs (for a given level of output)

Answer 40

A firm producing a positive output has flexibility to adjust its inputs allowing: - To choose the most efficient production method - The cheapest combination of all inputs

Question 41

What does the LRAC show?

Answer 41

Lowest per-unit cost at any output that can be produced after the firm has had the time to make all appropriate adjustments in its plant size

Question 42

How can we draw the LRAC

Answer 42

A combination of all the minimum points of the SRAC curves