Week 3 Flashcards
(89 cards)
1
Q
what is opportunity cost?
A
the cost of any activity measured in terms of the best alternative forgone, it measures in terms of the sacrifice made in doing it.
2
Q
what are explicit costs?
A
the payments to outside suppliers of inputs, it involve the direct payment of money by firms
3
Q
what are implicit costs?
A
they are the costs that do not involve a direct payment of money to a third party, but that, nevertheless, involve a sacrifice of some alternative. eg when a firm owns factors such as machinery
4
Q
what are historic costs?
A
the original amount the firm paid for factors it now owns
5
Q
what are sunk costs?
A
costs that cannot be recouped eg by transferring assets to other users
6
Q
what are replacement costs?
A
what the firm would have to pay to replace factors it currently owns
7
Q
what are fixed factors?
A
it is an input that cannot be increased in supply within a given time period eg building
8
Q
what are variable factors?
A
an input that can be increased in supply within a given period of time
9
Q
what is short run?
A
the period of time over which at least some factor is fixed, this means that in the short run, output can be increased only by using more variable factors
eg. a shipping line wanted to carry more people in response to a rise in demand, it could accommodate more people on the existing sailings if there was space. it could increase the number of sailings with its existing fleet by hiring more crew and using more fuel. BUT IN THE SHORT RUN, it couldn’t be buy more memberships those would not be time for them to be built
10
Q
what is the long run?
A
its the period of time long enough for all factors to be varied. therefore, in the long run, the shipping company could have a new ship built to cater for the increase in demand
11
Q
what is the law diminishing (marginal) returns?
A
when one or more factors are hold fixed, there will come a point beyond which the extra output from additional units of the variable factors will diminish.
- adding an additional factor of production results in smaller increases in output.
12
Q
what is total physical product?
A
the total output from a product per period of time that is obtained from a given amount of time
13
Q
what is production function?
A
the mathematical relationship between the output of a good and the inputs used to produce it. it shows how output will be affected by changes in the quantity of one or more of the inputs
14
Q
what is average physical product (APP)?
A
the total output (TPP) per unit of the variable factor in question
- total output divided by the amount of the input employed
15
Q
what is the marginal physical product?
A
the extra output gained by the employment of one more unit of the variable factor
- the triangle indicates the change in
16
Q
in marginal physical product why do we divide the increase in output by the increase in the quantity of the variable factor?
A
some variable factors can be increased only in multiple units
17
Q
what are fixed costs?
A
the total costs that don’t vary with the amount of output produced
18
Q
what are the variable costs?
A
the total costs that do vary with the amount of output produced
19
Q
what is total cost (TC)?
A
the sum of the total fixed costs (TFC) and total variable costs (TVC), its a horizontal straight line
20
Q
what is average (total) costs (AC)?
A
total costs (fixed plus variable) per unit of output
- average cost can be divided into the two components , it equals AFC plus AVC
21
Q
what is average fixed cost (AFC)?
A
total fixed costs per unit of output
22
Q
what is average variable cost (AFC)?
A
total variable cost per unit of output
23
Q
what is total variable cost (TVC)?
A
with zero output, no variable factors will be used. the TVC curve, therefore it starts from the origin, the shape follows the law of diminishing return.
- initially, before diminishing returns set in, TVC rises less and less rapidly as more variable factors are added
24
Q
What is marginal cost?
A
its the extra cost of producing one more unit,
- that is the rise in total cost per one unit rise in output. All marginal costs are variable, and by definition there can be no extra fixed costs as output rises
25
what is the shape of the marginal and average cost curves?
MC: the shape of the MC curve follows directly from the law of diminishing returns, initially as more of the variable factor is used, extra units of output cost less than previous units so MC falls.
- beyond a certain level of output, diminishing returns set in, MC then rises, additional units of output cost more and more to produce, since they require ever-increasing amounts of the variable factor
AFC: this falls continuously as output rises, since total fixed costs are being spread over a greater and greater output
26
what does average variable cost (AVC) and average (total cost (AC) look like on a graph?
AVC: the shape of the AVC curve depends on the shape of the APP curve. the average product of workers rise, the average labour cost per unit of output the (AVC) falls up to a point, then APP falls and AVC rises
AC: it is the vertical sum of the AFC and AVC curves. as AFC falls, the gap between AVC and AC narrows. although AVC and MC curves are usually drawn as a U-shape, they're not always shaped like this
27
what is the relationship between average cost and marginal cost?
as long as the cost of additional units of output is less than the average, their prodution must pull the average cost down.
- so if MC is less than AC, Ac must be falling
equally, if additional units cost more than the average, their production must be drive the average up
- that is MC is greater than AC, AC must be rising. therefore, the MC crosses the AC, and also the AVC at their minimum points
28
what are all factors in the long run?
the factors of production are all variable. so when a firm plans in the long run, a firm will have to make a number of decisions, about the scale of its operations, the location of its operations and the techniques of production it iwll use
29
what is constant returns to scale?
this where a given percentage increase in inputs leads to the same percentage increase in ouput
30
what is increasing returns to scale?
this is where a given percentage increase in inputs leads to a large percentage increase in output
31
what is decreasing returns to scale?
this is where a given percentage increase in inputs leads to a smaller percentage increase in ouput
32
what is economies of scale?
when increasing the sale of production leads to a lower cost per unit of output
33
why do firms experience economies for scale?
- specialisation and division of labour
- indivisibilities
34
what is specialisation and division of labour?
where production is broken down into a number of simpler, more specialised tasks, then allowing workers to have a higher degree of efficiency
35
what is indivisibilities?
the impossibility of dividing a factor of production into smaller units
- the problem with this its made worse when there are different machines for example, each of which is part of the production processes are of a different size
36
what is the container principle?
any capital equipment that contains things eg pipes, vats will tend to cost less per unit of output, the larger tits size
37
what is plant economies of scale?
economies of scale that arise because of the large size of the factory.
38
what is rationalisation>?
the reorgnising of production (often after a merger) so as to cut out waste and duplication and generally to reduce costs
39
what are overheads?
costs are arising from the general running of an organisation and only indirectly related to the level of output
40
what are economies of scope?
when increasing the range of products produced by a firm reduces the cost of producing each one
41
what are diseconomies of scale?
where costs per unit of output increase as the scale of production increases
42
what are the problems of diseconomies of scale?
- management problems of coordination may increase between the firm
- workers may feel alienated
- industrial relations may deterioate
- production line processes can lead to disruption
43
what is a cluster (business or industrial)?
a geographical concentration of related businesses and institutions
44
what can firms do in the long run?
a firm move to a different location
- the location will affect the cost of production, since locations differ in terms of the availability and cost of raw materials, land and power supply
45
what is external economies of scale?
where a firms costs per unit of output decrease as the size of the whole industry grows, so the firm benefits from the industry growing
46
what is the industry's infrastructure?
the network of supply agents, communications, skills, training facilities, distribution channels, specialised financial services etc that support a particular industry
47
what is external diseconomies of scale?
where a firms costs per unit of output increase as the size of the whole industry increases
48
what is technical or productive efficiency?
the least combination of factors for a given output,
49
what will a profit-maximising firm do?
it will want to use the least costly combination of factors to produce any given output, it will then substitute factors, one for another, by doing this it will reduce the cost of a given output
50
what is very short run (immediate run)?
all factors are fixed. output it fixed. the supply curve is vertical
- in short run, at least one factor in fixed supply, more can be produced by increasing the quantity of the variable factor, but the firm will come against the law of diminishing returns as it tries to do so
51
what is very long run?
all factors are variable and their quality, and so productivity can change. labourers productivity can increase as a result of education, training, experience etc
- whereas long run, all factors are variable. the firm may experience constant, increasing or decreasing returns to scale but although, all factors can be increased or decreased they're of a fixed quality
52
how do all the runs increase output?
very short run: it accepts for a few days it wont be able to increase output,
short run: it negotiates with labourers to introduce overtime working, order extra materials from suppliers
long run: start to build a new factory
very long run: it introduces a programme of research and development and training to increase productivity
53
what is long run average cost curve (LRAC)?
a curve that shows how average cost varies with output on the assumption that all factors are variable. it is assumed that the least-cost method of production will be chosen for each output.
- areas above the LRAC are attainable levels of cost
- areas below the LRAC are unattainable level of cost
54
what are the assumptions behind the long-run average cost curve?
- factor prices are given. at each level of output a firm will be faced with a set of factor prices, so short and long run cost curves will shift
- state of technology and factor quality are given: assumed to only change in the very long run, if a firm gains economies of scale, its due to being able to exploit existing tech
- firms choose the least cost-combination of factors for each output: assumption here is that firms operate efficiently, that they choose the cheapest possible way of producing any level of output
55
what is envelope curve?
a long run average cost curve drawn as the tangency points of series of short run average cost curves
- LRAC envelopes the SE cost curves
56
how are LRAC curves drawn?
it can be downward sloping, upward sloping, horizontal or vertical, depending on whether they are economies of scale or diseconomies of scale or neither
- the LRAC curves are saucer shaped or l-shaped. as output expands, initially there are economies of scale. when these are exhausted the curve will become flat.
- when the firm becomes very large, it may begin to experience diseconomies of scale. if it happens, the LRAC curve will begin to slope upward again
57
what happens when the marginal physical product (MPP) is above average physical product (APP)?
average physical product (APP) will rise. once MPP has fallen below APP, however APP will fall
58
what is total revenue (TR)?
its the firms total earnings per period of time from the sale of a particular amount of output (Q)
- multiply both
59
what is average revenue (AR)?
its the average amount the firm earns per unit sold
- divide
60
what is marginal revenue?
its the extra total revenue gained by selling one unit more per time period.
61
what is a price taker?
if a firm is small relative to the whole market, its likely to be a price taker. it has to accept the price given by the intersection of demand and supply in the whole market, its too small too be able to influence the market price
62
how does average revenue affected by a firms output when price doesnt vary?
if a firm is a price taker, at this price, the firm can sell as much as its capable of producing, but if it increases price it would lose its sale to competition
- charging a lower price wouldn't be beneficial as the firm can cell as much as it can at the prevailing price
63
how is marginal revenue affected by ouput when price doesnt vary?
in a horizontal demand curve, the marginal revenue curve will be the same as the average revenue curve, since selling one more unit at a constant price (AR) merely adds to the amount to total revenue (TR)
64
how is total revenue affected by output when price doesnt vary?
as price is constant, total revenue will rise at a constant rate as more is sold. the TR curve will therefore be straight line through the origin
65
how is average revenue affected by output when price varies?
average revenue = price.
if the price has to be reduced to sell more output, average revenue will fall as output increases
66
what is a price marker?
a firm that has the ability to influence the price charged for its good or service
- rather than accepting (or taking) the market price, firms generally would prefer to be a price marker. this means that if a firm wants to sell more, it must lower its price
- they will have a downward sloping demand curve
67
how is marginal revenue affected by output when price varies?
when a firm faces a downward sloping demand curve, marginal revenue will be less that average revenue and may be negative
- if a firm is to sell more per time period, it must lower its price which means it the marginal revenue is the price at which it sells the last unit, minus the loss in revenue it has incurred in reducing the price
68
what is the relationship between marginal revenue and price elasticity of demand?
if demand is price elastic, a decrease in price will lead to a larger increase in the quantity demanded and hence increase in revenue, MR will then be positive
if demand is inelastic, a decrease in price will lead to a smaller increase in sales, the price reduction will more than offset the increase sales and so MR will be negative
69
how is total revenue affected by output when price varies?
total revenue = price times quantity. the TR curve is not a straight line, its a curve that rises at first and then falls
- as long as MR is positive and demand is elastic, a rise in output will raise total revenue.
- when MR is negative, and demand is inelastic, the TR curve will be where MR = 0. price elasticity of demand here will be equal to -1
70
what is profit maximising rule?
if profits are to be maximised, it where MR = MC
71
what is long run profit maximisation?
assuming that MR and AR curves are the same in the long run as in the short run, long run profits will be maximised at the output where MR = the long run MC
72
what is normal profit?
the opportunity cost of being in business, it consists of the interest that could be earned on a riskless asset, plus a return for risk-taking in this particular industry. its counted as a cost production
% = rate of interest on a riskless loan + a risk premium
73
what is supernormal profit (aka pure profit, economic profit, abnormal profit or profit)?
the excess of profit over normal profit, where AR is greater than AC
74
what is short run down point?
this is where the MR curve is tangential to the AVC curve. the firm can only just curve its variable cost. any fall in revenue below this level will cause a profit-maximising firm to shut down immediately
75
what is long-run shut down point?
this is where the AR curve is tangential to the LRAC curve. the firm can just make normal profits, any fall in revenue below this level will cause a profit-maximising firm to shut down once all costs have become variable
76
for a firm that cannot make a profit at any level of output what happens?
the point where MR = MC represents the loss-minimising output
77
in the short run, when will a firm close?
if it cannot cover its variable costs, in the long run, it will close down if it cannot make normal profits
78
what are incremental costs? what are the 3 types of relevant incremental costs?
costs incurred due to a decision
1) Present Period Explicit Costs
2) Opportunity Costs
3) Future Costs
79
what are incremental revenues? what are the 2 types?
Incremental profit is the profit gain or loss associated with a given managerial decision
1) Direct Returns
2) Costs avoided
80
what is the difference between short run and long run?
In the short-run at least one factor is fixed
- Hence the of existence diminishing marginal returns
In the long run all factors can be varied.
- This means the scale of the operations can be altered.
- Each possible scale of operations will have its own associated short-run average cost curve (SRAC).
- Output scale based on demand forecasts
81
what are internal and external economies?
internal: plant level economies, organisational level economies
external: research, pool of trained labour, education/ training
82
what are the key sources and implications of economies of scope?
sources:
1) Common inputs;
2) Inputs which can be leveraged at low cost from one
application to another;
3) By-products.
implications:
1. Can overcome benefits of incumbent firms, thus
reducing barriers to entry;
2. Can erect a barrier to entry requiring a full product
range to enter the market.
3. Show imperative for firms to find additional revenue
streams which they can exploit.
83
What are the sources of cost advantage that firms should exploit?
1. External economies from geographical concentration of
specialist suppliers.
2. Firms can reduce costs by process innovations.
- Discovering new sources of supply, new ways of working (e.g. standardisation,
- Improved organizational design / Resource Management.
3. Choice of location.
- Availability, suitability and cost of factors of production.
4. Experience curve effect (lowers costs)
- Workers more practiced (lowers labour cost)
- Managers are better able to organise production via: standardisation, specialisation, product redesign, networking for resources
- Important strategic implications = maintaining a dominant
position. Although not infinite, subject to a ‘sudden stop’!
- However, on the flip side - too much emphasis risk losing
flexibility and innovation.
84
what is the optimal amount of variable factor?
The optimal amount of any variable factor to employ is where the
marginal cost just equals the marginal benefit
MCl = VMPl
Where marginal cost of labour (MCl) equals the value of the marginal product of labour (VMPl)
85
Why are average costs important?
Useful for two decisions:
1. What price to charge
2. Deciding whether or not to continue to produce something
86
What does controlling costs ensure?
An optimum level of productivity
The production function focuses on the ability to supply.
Where inputs: raw materials, capital (K), and labour (L)
Q= f(K,L)
- in the short run capital may be fixed, the managers ONLY SHORT RUN decision is how much labour to hire
87
What can be increased in the long run for productivity?
Capital can be increased,
Manager can use short run calculations of marginal productivity to decide future investment in capital (K)
- if they’re operating in decreasing returns to labour, may suggest more capital for the next period
88
When does neoclassical theory suggest a short run and long run term should shut down?
Short run: when price (P) is equal to AVC
Long run: when price (P) is equal to AC
- assume fixed costs cannot be recovered as they are SUNK COSTS
89
What is adverse selection?
generally to a situation in which sellers have information that buyers do not have or vice versa
