Ch 14: Costs, Production Functions, and Scale Analysis

What is a production function?

A mathematical representation showing the relationship between inputs and outputs in production.

What is marginal product?

The additional output generated by adding one more unit of a specific input.

How is marginal product related to production functions?

Marginal product indicates how output changes as the quantity of an input changes, reflecting efficiency in production.

What are total revenue and its formula?

Total revenue (TR) is the total amount a firm receives from selling its output, calculated as TR = Price (P) × Quantity (Q).

What is total cost?

The market value of all inputs used in production, including both explicit and implicit costs.

How is profit calculated?

Profit is calculated as Profit = Total Revenue (TR) - Total Cost (TC).

What are explicit costs?

Costs that require a direct outlay of money by the firm, such as wages and rent.

What are implicit costs?

Costs that do not require a direct outlay of money, representing the opportunity cost of using resources.

What is the relationship between total cost and its components?

Total cost is the sum of explicit costs and implicit costs.

What is the difference between accounting profit and economic profit?

Accounting profit is total revenue minus total explicit costs, while economic profit accounts for both explicit and implicit costs.

Why do accounting profits typically exceed economic profits?

Because accounting profit ignores implicit costs, which are factored into economic profit calculations.

What are economies of scale?

Cost advantages that firms experience as their scale of operation increases, leading to lower average costs.

What are diseconomies of scale?

Increases in per-unit costs as a firm grows too large, leading to inefficiencies.

What are constant returns to scale?

A situation where an increase in inputs results in a proportional increase in output.

How did Jelani's Gelato Shop calculate its profit?

By determining total revenue of $75,000 and total costs of $65,000, resulting in a profit of $10,000.

What are the explicit costs for Jelani's Gelato Shop?

Explicit costs include $20,000 for raw materials and $12,000 for rent, totaling $32,000.

What is Jelani's implicit cost?

The opportunity cost of her time, valued at $25,000, plus forgone interest of $3,000.

What is the total cost for Jelani's Gelato Shop?

Total costs are the sum of explicit costs ($32,000) and implicit costs ($25,000), totaling $57,000.

What is the opportunity cost of capital for Jelani?

The opportunity cost of capital is $8,000 per year, calculated from the interest on her investments.

How does an increase in rent affect accounting and economic profit if you rent your office space?

Both accounting and economic profits decrease by the amount of the rent increase.

How does an increase in rent affect accounting and economic profit if you own your office space?

Accounting profit remains unchanged, while economic profit decreases due to increased implicit costs.

What is the production function?

The relationship between the quantity of inputs used to make a good and the quantity of output of that good.

What happens to the production function as production rises?

It gets flatter.

What is the marginal product of labor (MPL)?

The increase in output that arises from an additional unit of labor, calculated as MPL = ∆Q / ∆L.

What does diminishing marginal product mean?

The marginal product of an input declines as the quantity of the input increases.

What is total cost (TC) in production?

Total cost is the sum of fixed costs (FC) and variable costs (VC).

What are fixed costs (FC)?

Costs that do not vary with the quantity of output produced and are incurred even if production is zero.

What are variable costs (VC)?

Costs that vary with the quantity of output produced.

How is average total cost (ATC) calculated?

ATC = TC / Q, which is the total cost divided by the quantity of output.

What is marginal cost (MC)?

The increase in total cost that arises from producing an extra unit of output, calculated as MC = ΔTC / ΔQ.

What does it mean when MC < ATC?

Average total cost is falling.

What does it mean when MC > ATC?

Average total cost is rising.

What is the significance of the point where the MC curve crosses the ATC curve?

It indicates the minimum point of the ATC curve.

In Xavier's example, how many buckets of popcorn does he produce with 1 worker?

30 buckets of popcorn per day.

What is the marginal product of the second worker in Xavier's example?

40 buckets of popcorn.

What is the marginal product of the fourth worker in Xavier's example?

20 buckets of popcorn.

Does Xavier's production function exhibit diminishing marginal returns?

Yes.

What is the daily cost of Xavier's popcorn truck?

$200 per day.

What is the market wage for popcorn makers in Xavier's example?

$50 per day.

What is average fixed cost (AFC)?

AFC = FC / Q, which is fixed costs divided by the quantity of output.

What is average variable cost (AVC)?

AVC = VC / Q, which is variable costs divided by the quantity of output.

How do the total cost (TC) and variable cost (VC) curves behave in Angel's example?

The TC and VC curves are parallel.

What is the relationship between marginal cost (MC) and average total cost (ATC) when MC is less than ATC?

ATC is falling.

What is the relationship between marginal cost (MC) and average total cost (ATC) when MC is greater than ATC?

ATC is rising.

What does 'rational people think at the margin' imply in production decisions?

It implies that decisions are made based on the additional benefits and costs of producing one more unit.

How does Xavier's output change with the addition of workers?

Output increases with each additional worker, but at a decreasing rate due to diminishing returns.

What is the total output produced by Xavier when he hires 5 workers?

100 buckets of popcorn per day.

What is the fixed resource in Xavier's popcorn production?

The popcorn truck.

What is the cost structure of Angel's knitting business?

Angel incurs fixed costs for knitting needles and variable costs for yarn and labor.

What happens to Average Total Cost (ATC) when Marginal Cost (MC) is greater than ATC?

ATC is rising.

Where does the MC curve cross the ATC curve?

At the minimum of the ATC curve.

What is the formula for Average Fixed Cost (AFC)?

AFC = FC/Q.

What is the formula for Average Variable Cost (AVC)?

AVC = VC/Q.

What is the relationship between Marginal Cost (MC) and Total Cost (TC)?

MC is the change in TC when output increases by one unit.

What is the formula for Average Total Cost (ATC)?

ATC = TC/Q.

What is the definition of economies of scale?

Long-run average total cost falls as the quantity of output increases.

What is the definition of constant returns to scale?

Long-run average total cost stays the same as the quantity of output changes.

What is the definition of diseconomies of scale?

Long-run average total cost rises as the quantity of output increases.

What does diminishing marginal product refer to?

The production function gets flatter as the quantity of an input increases.

What is the relationship between average total cost and output?

Average total cost first falls as output increases and then rises.

What is the significance of the MC curve in relation to the ATC curve?

The MC curve always crosses the ATC curve at the minimum of ATC.

What is the difference between explicit costs and implicit costs?

Explicit costs are direct payments made, while implicit costs are the opportunity costs of using resources.

What is economic profit?

Economic profit takes both explicit and implicit costs into account.

What is accounting profit?

Accounting profit considers only explicit costs.

What is the typical shape of a long-run average total cost (LRATC) curve?

It is typically U-shaped due to economies and diseconomies of scale.

What happens to average total cost in the short run when production levels change?

Many costs are fixed in the short run but variable in the long run.

What is the effect of hiring additional workers on production according to the neighbor's example?

Production can increase significantly due to increased specialization.

What is the minimum efficient scale in production?

The lowest point at which a firm can produce its output at the minimum average total cost.

What is the role of factory size in long-run production decisions?

Firms can choose different factory sizes based on the quantity of output they plan to produce.

What does the term 'total cost' encompass?

Total cost is the sum of fixed costs and variable costs.

What is the impact of production on total cost as output increases?

The total-cost curve gets steeper as the quantity produced rises.

What is the significance of the average total cost curve in production analysis?

It helps determine the most efficient level of production for a firm.

What is the relationship between short-run and long-run costs?

Short-run costs may rise more than long-run costs when production levels change.