Microeconomics chap 6-7

Firm structure

Firm structure

The organization and legal structure of a firm, such as sole proprietorship, partnership, or corporation.

Expansion strategies

The decisions made by a firm to adjust its operations in the short run and make long-term investments to grow and expand.

Economic theory

The principles and concepts that guide firms in making decisions about production processes, input usage, and output volume.

Ownership and management of the firm

The relationship between the owners and managers of a firm, and how decisions are made.

Private firm

A firm owned by individuals or non-governmental entities with the goal of making a profit.

Public firm

A firm owned by the government or government agencies.

Non-profit firm

An organization that is not owned by the government and does not aim to make a profit, but rather pursues social or public objectives.

Sole Proprietorship

A legal structure where a firm is owned by a single individual.

Partnership

A legal structure where a firm is jointly owned and controlled by two or more people.

Corporation

A legal structure where a firm is owned by shareholders who elect a board of directors to hire managers. Owners have limited liability.

Limited liability

The concept that protects the personal assets of owners from the debts of a corporation.

Management of firms

The process of making decisions and overseeing the operations of a firm, which can involve owners, managers, and supervisors.

Profit maximization

The goal of owners to maximize the difference between revenue and costs in order to stay competitive.

Efficient production

Producing the current output level with the least amount of inputs based on existing knowledge.

Production function

The relationship between the inputs used by a firm and the maximum output that can be achieved.

Capital services

Long-lived inputs like land, buildings, and equipment.

Labor services

Hours of work from managers, skilled, and less-skilled workers.

Materials

Natural resources, raw goods, and processed products consumed or incorporated in the final product.

Short run

A time frame where at least one factor of production cannot be practically changed by the firm.

Fixed input

A production factor that a firm cannot easily change or adjust during the short run.

Variable input

A production factor that the firm can readily adjust or change within the relevant short-run period.

Long run

An extended period in which a firm has enough time to adjust or change all factors of production as needed.

Short-run production

Production adjustments made by varying only the variable inputs like labor, raw materials, or energy consumption in the short run.

Marginal Product of Labor

The additional output produced from adding one more unit of labor.

Average Product of Labor

The average output produced per unit of labor input.

Law of Diminishing Marginal Returns

As a firm increases a particular input while holding other inputs and technology constant, the corresponding increases in output will become smaller eventually.

Isoquants

Represents the different combinations of labor and capital that allow a firm to produce a specific level of output.

Marginal rate of technical substitution (MRTS)

Measures how easily a firm can exchange one input for another while keeping output constant.

Returns to scale

Refers to how changes in inputs like labor and capital affect the output in a production process that employs the same technology.

Increasing Returns to Scale

If a firm doubles its inputs and output more than doubles.

Constant Returns to Scale

If a firm doubles its inputs and output exactly doubles.

Decreasing Returns to Scale

Occur when doubling inputs results in less than a doubling of output.

Productivity

Differences in technology and managerial practices contribute to variations in firms' output from the same inputs.

Technical change

Technological advancements and managerial innovations enable firms to increase productivity, producing more with the same resources.

Innovations

The pursuit of efficiency, firms strive to incorporate the latest technological and managerial advancements in their production processes.

Opportunity cost

The value of the best alternative use of a resource.

Opportunity cost of capital

Refers to the value of the best alternative use of durable assets like equipment or land.

Sunk cost

Money spent in the past that cannot be recovered.

Short run

A firm faces costs that increase as it produces more, with certain inputs being fixed and others being variable.

Variable costs

Fluctuate with the level of output, involving items such as labor and materials.

Total cost

The sum of fixed cost and variable cost to produce a specific quantity of output.

Marginal cost

The change in total cost when producing one more unit of output.

Average fixed cost

The fixed cost divided by the number of units produced.

Average variable cost

The variable cost divided by the quantity of output produced.

Average cost

The sum of average fixed cost and average variable cost, showing the overall cost per unit of output.

Fixed Cost Curve

A straight line representing costs that do not change with changes in output. It remains constant regardless of the production level.

Variable Cost Curve

Starts at zero when production is at zero and increases with output because these costs vary with the number of units produced.

Total Cost Curve

A parallel line to the VC-curve, which is "amount of the FC" higher than the VC.

Relationship Between Marginal Cost and Average Cost

When MC is below ATC or AVC, the average cost decreases. When MC is above ATC or AVC, the average cost increases. At the minimum point of the average cost curve, MC equals ATC.

Taxes

If a tax is imposed per unit of output, it increases both average variable cost (AVC) and average cost (AC) by that tax amount. Marginal cost (MC) and average cost curves shift upward by the tax amount. Franchise taxes, which are fixed lump-sum payments unrelated to output, only impact fixed costs.

Long-Run Costs

In the long run, all costs are avoidable, and fixed costs are considered variable costs. Fixed costs in the short run are often considered sunk costs, while in the long run, they are avoidable.

Long Run Total Cost Equals Long-Run Variable Cost

In the long run, the total cost of production is equivalent to the long-run variable cost. There are no fixed costs in the long run.

Minimizing Costs

A firm can minimize its cost by using the lowest-isocost rule, tangency rule, or last-dollar rule. The lowest-isocost rule suggests picking the bundle of inputs where the lowest isocost line touches the isoquant. The tangency rule suggests picking the bundle of inputs where the isoquant is tangent to the isocost line. The last-dollar rule suggests picking the bundle of inputs where the last dollar spent on one input gives as much extra output as the last dollar spent on any other product.

Isocost Line

All the combinations of inputs that require the same total expenditure (cost). The cost of producing a given level of output depends on the price of labor and capital.

Long-Run Expansion Path and the Long-Run Cost Function

The expansion path is a line through the tangency points, representing the cost-minimizing combinations of labor and capital for each output level. The long-run cost function shows the relation between the cost and the total output.

The Shape of Long-Run Cost Curves

The shapes of the average cost and marginal cost curves depend on the shape of the long-run cost curve. The long-run average cost curve falls when the long-run marginal cost curve is below it and rises when the long-run marginal cost curve is above it. The marginal cost crosses the average cost curve at the lowest point on the average cost curve.

The Learning Curve

Learning by doing refers to the productive skills and knowledge that workers and managers gain from experience. A firm's average cost may fall over time due to learning by doing. Learning is a function of cumulative output, and there is a relationship between average costs and cumulative output. If a firm is operating in the economies of scale section of its average cost curve, expanding output lowers its cost for two reasons.