Microeconomics: Firms in Factor Markets

This set of vocabulary flashcards covers concepts from Microeconomics Chapter 9 regarding firms in factor markets, productivity, production functions, isoquants, returns to scale, and cost minimization.

Production function

The relationship between the quantity of inputs used to produce a good and the quantity of output of that good, represented by the formula $q = f(L,K)$.

Average productivity (AP)

The measure of productivity per unit of input; for labour, it is calculated as total output divided by the quantity of labour ($AP_L = \frac{q}{L}$).

Marginal productivity (MP)

The increase in output resulting from an additional unit of input; mathematically, it is the partial derivative of the production function with respect to that input (e.g., $MP_L = \frac{\text{change in output}}{\text{change in labour}}$).

Law of diminishing returns

The phenomenon where, after a certain turning point in a production process, the additional returns (marginal productivity) start to decrease as more units of an input are added.

Production isoquant

A curve showing all combinations of labour ($L$) and capital ($K$) that, when used optimally, produce a given, constant level of output.

Axiom of transitivity

The principle stating that if a producer prefers input mix A over mix B, and mix B over mix C, they must prefer mix A over mix C, implying that isoquants cannot intersect.

Marginal rate of technical substitution (MRTS)

The slope of the tangent to the isoquant at a specific point, representing the negative of the ratio of the marginal products of labour and capital ($-MRTS = \frac{MP_L}{MP_K} = \frac{\text{Δ}K}{\text{Δ}L}$).

Leontief technology

A production process that uses inputs in fixed proportions, where inputs such as rubber ($R$) and steel ($S$) are perfect complements, resulting in L-shaped isoquants.

Increasing returns to scale

A situation where a proportional increase in all production factors ($L$ and $K$) by a scaling factor $\text{λ} > 1$ results in a more than proportional increase in total production ($TP(\text{λ}L, \text{λ}K) > \text{λ} \times TP(L,K)$).

Constant returns to scale

A situation where total production increases exactly in proportion to the expansion of all production factors ($TP(\text{λ}L, \text{λ}K) = \text{λ} \times TP(L,K)$).

Decreasing returns to scale

A situation where total production increases less than proportionately when all production factors are expanded by a scaling factor ($TP(\text{λ}L, \text{λ}K) < \text{λ} \times TP(L,K)$).

Cobb-Douglas production function

A common functional form for production $q = AL^{\text{α}}K^{\text{β}}$, where $A$ is a scaling factor for technology, and $\text{α}$ and $\text{β}$ are output elasticities of labour and capital.

Isocost curve

A line showing all combinations of labour and capital that cost the firm the same total amount, defined by $K = \frac{TC}{r} - (\frac{w}{r})L$, where $w$ is the wage and $r$ is the cost of capital.

Expansion path

A curve that describes how the cost-minimizing combination of production factors changes as the company increases its output level.

Economies of scale

A situation in which the long-run average cost (AC) falls as the quantity of output increases, often caused by specialization or technological advantages.

Diseconomies of scale

A situation in which the long-run average cost (AC) rises as output increases, typically due to coordination, communication, or management problems in large organizations.

Substitution effect

The adjustment of the input mix by a producer when the relative price of an input changes; for example, replacing labour with capital if wages ($w$) increase.

Output elasticity of labour

Represented by $\text{α}$ in the Cobb-Douglas function, it measures the extent to which output changes relative to a change in the number of units of labour.