Economics Flashcards

Background to Supply

Short-run Theory of Production

• Profits and Aims of the Firm:

  • Traditional and alternative theories.

  • In the short run, firms aim to maximize profits by analyzing production functions and understanding the relationship between input variables and output.

• Long-run vs. Short-run Production:

  • Fixed and variable factors of production.

• Law of Diminishing Returns:

  • When increasing amounts of a variable factor are used with a given amount of a fixed factor, there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.

Short-run Production Function

• Total Physical Product (TPP)

• Average Physical Product (APP)

  • APP={TPP}/{QV}

• Marginal Physical Product (MPP)

  • MPP={\Delta TPP}/{\Delta QV}

Example: Wheat Production

Graphical Relationship

• Relationship between TPP, APP, and MPP is shown graphically.

• TPP increases with the number of farm workers up to a point, then declines.

• Diminishing returns set in at a certain point.

• MPP illustrates the change in TPP with each additional worker.

Short-run Costs

• Measuring Costs of Production:

  • Fixed Costs: Costs that do not change with the level of output, such as rent and salaries.

  • Variable Costs: Costs that vary with the level of production, including raw materials and labor.

  • Total Costs: The sum of fixed and variable costs at a given level of output.

    • Explicit Costs

    • These are direct, out-of-pocket expenses that a firm incurs during the production process, such as wages, rent, and material costs.

    • Implicit Costs

    • These represent the opportunity costs of utilizing resources owned by the firm, reflecting the income that could have been earned if those resources were employed in their next best alternative use.

• Fixed Costs and Variable Costs:

  • Fixed Costs and Sunk Costs

• Total Costs:

  • Total Fixed Cost (TFC)

  • Total Variable Cost (TVC)

  • Total Cost (TC)

    • TC = TFC + TVC

Example: Total Costs for Firm X

Cost Curves

• TFC is constant regardless of output.

• TVC increases with output.

• TC is the sum of TFC and TVC.

• Diminishing marginal returns affect the shape of TVC and TC.

Marginal Cost (MC)

• Marginal Cost and the Law of Diminishing Returns

• Relationship between Marginal and Total Cost Curves

Average Costs

• Average Fixed Cost (AFC)

• Average Variable Cost (AVC)

• Average (Total) Cost (AC)

• Relationship between AC and MC

Example: Total, Average, and Marginal Cost for Firm X

• AFC decreases as output increases.

• AVC, AC, and MC are U-shaped due to diminishing returns.

• MC intersects AC at its minimum point.

Long-run Theory of Production

• All factors variable in the long run.

• Scale of Production:

  • Increasing Returns to Scale

  • Constant Returns to Scale

  • Decreasing Returns to Scale

Economies of Scale

• Specialization and Division of Labor

• Indivisibilities

• Container Principle

• Greater Efficiency of Large Machines

• By-products

• Multi-stage Production

• Organizational and Administrative Economies

• Financial Economies

• Economies of Scope

Diseconomies of Scale

• Managerial Complexity

• Alienation

• Industrial Relations Problems

• Disruption if part of complex production chains fail

External Economies and Diseconomies of Scale

Location

• Costs vary in different locations

• Transport Costs: Location relative to market and suppliers

Optimum Combination of Factors

• Two-factor case:

  • If{MPPa}/{Pa}>{MPPb}/{Pb} costs can be reduced by using more factor a and less factor b.

  • Costs minimized where: MPPa/Pa = MPPb/Pb

• Multi-factor case:

  • Costs minimized where: MPPa/Pa= MPPb/Pb = … MPPn/Pn

  • (the equi-marginal principle)

Isoquant-Isocost Analysis

Isoquants

• Shape of isoquants.

• Diminishing Marginal Rate of Substitution (MRS)

• Isoquant Map

Diminishing Marginal Rate of Substitution (MRS)

• MRS = frac{\Delta K}{\Delta L}

Isocosts

• Slope and position of the isocost.

• Shifts in the isocost.

Least-cost Combination of Factors for a Given Output

• Point of Tangency

• Comparison with Marginal Productivity Approach

Highest Output for a Given Cost of Production

Long-run Costs

Long-run Average Costs (LRAC)

• Shape of the LRAC curve.

• Assumptions behind the curve.

Alternative LRAC Curves

• Economies of Scale

• Diseconomies of Scale

• Constant Costs

Long-run Marginal Costs (LRMC)

Relationship between Long-run and Short-run Average Costs

• The Envelope Curve

Revenue

Defining Total, Average, and Marginal Revenue

Revenue Curves When Firms Are Price Takers (Horizontal Demand Curve)

• Average Revenue (AR)

• Marginal Revenue (MR)

• Total Revenue (TR)

Revenue Curves When Price Varies with Output (Downward-Sloping Demand Curve)

• Average Revenue (AR)

• Marginal Revenue (MR)

• Total Revenue (TR)

• Revenue Curves and Price Elasticity of Demand

• Shifts in Revenue Curves

Profit Maximisation

Using Total Curves

• Maximizing difference between TR and TC

• The Total Profit Curve

Using Marginal and Average Curves

• Stage 1: Profit Maximized where MR = MC

• Stage 2: Using AR and AC Curves to Measure Maximum Profit

Some Qualifications

• Long-run Profit Maximization

• The Meaning of Profit

What if a Loss Is Made?

• Loss Minimizing: Still Produce where MR = MC

• Short-run Shut-down Point: P = AVC

• Long-run Shut-down Point: P = LRAC