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Questions and Answers
What is the total amount of explicit costs calculated in the accounting profit approach?
What is the total amount of explicit costs calculated in the accounting profit approach?
What is the economic profit calculated after considering both explicit and implicit costs?
What is the economic profit calculated after considering both explicit and implicit costs?
In the short run, which statement is true regarding input factors?
In the short run, which statement is true regarding input factors?
Which type of cost is included when calculating economic profit but not accounting profit?
Which type of cost is included when calculating economic profit but not accounting profit?
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What does the equation Q = f(K, L) represent in production?
What does the equation Q = f(K, L) represent in production?
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What is the opportunity cost for the implicit wage in the economic profit calculation?
What is the opportunity cost for the implicit wage in the economic profit calculation?
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At which stage of production is the total product increasing but at a decreasing rate?
At which stage of production is the total product increasing but at a decreasing rate?
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What happens to the average product when the marginal product is below the average product?
What happens to the average product when the marginal product is below the average product?
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Which of the following best describes a fixed input?
Which of the following best describes a fixed input?
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To increase production in the short run, a firm primarily needs to:
To increase production in the short run, a firm primarily needs to:
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In which scenario is the marginal product equal to zero?
In which scenario is the marginal product equal to zero?
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Which of the following statements about the relationship between total product and marginal product is true?
Which of the following statements about the relationship between total product and marginal product is true?
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What is the marginal product when labor input is increased to 8?
What is the marginal product when labor input is increased to 8?
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What defines an implicit cost?
What defines an implicit cost?
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How is economic profit calculated?
How is economic profit calculated?
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What is the relationship between accounting profit and economic profit?
What is the relationship between accounting profit and economic profit?
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What does a firm that earns a normal profit signify?
What does a firm that earns a normal profit signify?
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In the example of Ali's business, what is his explicit cost for wages?
In the example of Ali's business, what is his explicit cost for wages?
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Which of the following is NOT considered in the calculation of economic profit?
Which of the following is NOT considered in the calculation of economic profit?
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What is Ali's implicit cost attributed to the building he owns?
What is Ali's implicit cost attributed to the building he owns?
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Which of the following best illustrates total opportunity costs?
Which of the following best illustrates total opportunity costs?
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What characterizes Stage I of production?
What characterizes Stage I of production?
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Why is Stage II considered the most efficient stage of production?
Why is Stage II considered the most efficient stage of production?
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What effect does adding more variable factors have in Stage III?
What effect does adding more variable factors have in Stage III?
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What is the principle behind the law of diminishing marginal returns?
What is the principle behind the law of diminishing marginal returns?
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What does the total product curve illustrate?
What does the total product curve illustrate?
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What happens to marginal product as more labor is employed, based on the given data?
What happens to marginal product as more labor is employed, based on the given data?
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Which stage of production should a producer avoid operating in?
Which stage of production should a producer avoid operating in?
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In what way does the marginal product curve relate to the total product curve?
In what way does the marginal product curve relate to the total product curve?
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What happens to the average magnitude when the marginal magnitude is above it?
What happens to the average magnitude when the marginal magnitude is above it?
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Which factors determine a firm's production function?
Which factors determine a firm's production function?
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What is indicated by diminishing returns in a production function?
What is indicated by diminishing returns in a production function?
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In the long run, how are all costs treated?
In the long run, how are all costs treated?
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What does a U-shaped cost curve in the short run indicate?
What does a U-shaped cost curve in the short run indicate?
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How does the average total cost (ATC) curve behave as plant size increases?
How does the average total cost (ATC) curve behave as plant size increases?
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What does the long-run average cost curve represent?
What does the long-run average cost curve represent?
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Which statement best reflects diminishing marginal product of capital?
Which statement best reflects diminishing marginal product of capital?
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What is the least-cost way of producing 13 sweaters a day?
What is the least-cost way of producing 13 sweaters a day?
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What does the long-run average cost (LRAC) curve represent?
What does the long-run average cost (LRAC) curve represent?
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Which of the following is a reason economies of scale exist?
Which of the following is a reason economies of scale exist?
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What characterizes diseconomies of scale?
What characterizes diseconomies of scale?
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What happens beyond the minimum efficient scale for a firm?
What happens beyond the minimum efficient scale for a firm?
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What is indicated by the long-run average total cost curve touching each short-run average total cost curve at only one point?
What is indicated by the long-run average total cost curve touching each short-run average total cost curve at only one point?
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Which of the following best describes constant returns to scale?
Which of the following best describes constant returns to scale?
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Why might a large firm experience difficulties in management coordination?
Why might a large firm experience difficulties in management coordination?
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Study Notes
Principle of Economics
- Noor Sa'adah Sabudin
- SEFB
Chapter 6: Production and Cost
- Explicit Cost and Implicit Cost
- Accounting Profit Versus Economic Profit
- Production: Short-Run Versus Long-Run
- Short-Run Production: Marginal Physical Product (MPP), Marginal Cost (MC), Average Productivity (AP)
- Graphical and numerical analysis
- Cost in the Short Run: Fixed Cost, Variable Cost, Total Cost, Average Fixed Cost, Average Variable Cost, Average Total Cost, Marginal Cost
- Relationship between production and cost
- Production and Cost in the Long Run
- Long-Run Average Total Cost Curve (LRATC)
- Economies, Constant and Diseconomies of Scale
Learning Objectives
- Explain the definitions of explicit and implicit costs.
- Explain the difference between accounting and economic profit.
- Differentiate short-run and long-run production.
- Explain short-run production (numerical/table and graph).
- Explain short-run costs (numerical/table and graph).
- Explain the relationship between marginal and average cost applied to production.
- Explain production and cost in the long run.
- Explain the concept and characteristics of economies of scale and diseconomies of scale.
The Behavior of Profit-Maximizing Firms
- All firms must make several basic decisions.
- These decisions are about output and production technology.
- The amount of each input needed also plays a crucial role.
Profits and Economic Costs
- Profit is the difference between total revenue (TR) and total cost (TC).
- π = (TR – TC)
- A firm's cost of production includes all opportunity costs of producing goods and services.
- Costs can be explicit or implicit.
Explicit Cost
- A cost incurred when an actual (monetary) payment is made.
- Examples: labor services, machinery, transport
Implicit Cost
- A cost that represents the value of resources used in production where no actual (monetary) payment is made.
- For example: wages, rent, or interest rate from the bank
Accounting Profit vs Economic Profit
- Economists measure economic profit as total revenue minus total cost, including both explicit and implicit costs.
- π = TR – (exp + imp)
- Accountants measure accounting profit as total revenue minus only explicit costs.
- π = TR – (exp)
Accounting Profit vs Economic Profit
- When total revenue exceeds both explicit and implicit costs, the firm earns economic profit.
- A firm that earns normal profit/zero economic profit earns revenue that's equal to its total costs (explicit + implicit costs).
- This level is necessary to keep resources employed in the firm.
Production: Short-Run vs Long-Run
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Fixed Input: An input that does not change according to the amount of output. (e.g., machinery, land, buildings)
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Variable Input: An input that changes according to the amount of output. (e.g., raw materials, electricity, labor)
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Short Run Period: A time frame in which at least one input is fixed, and the other inputs can be changed.
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Long Run: A time frame where all inputs are variable.
Production in the Short Run
- Output increases as labor increases in the short run (assuming at least one input, like capital, is fixed).
- Total Product (TP): Total output produced in a given period.
- Marginal Product (MP/MPP): Change in total product resulting from a one-unit increase in the quantity of labor.
- Average Product (AP/APP): Total product divided by the quantity of labor employed.
Production in the Short Run: Stages of Production
- Stage I: Proportion of fixed factors greater than variable factors. Underutilization of fixed factors. Operation involves a waste of resources.
- Stage II: Law of diminishing marginal returns. Most efficient stage. Input combinations are fully utilized.
- Stage III: Proportion of fixed factors lower than the variable factors. Increased variable factors reduce total product due to overcrowding. The producer does not operate at this stage.
Production in the Short Run: Product Curves
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Product curves show how a firm's total product, marginal product, and average product change as the quantity of labor employed changes.
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Relationship between Total Product (TP) and Marginal Product (MP)
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MP increasing, then TP increases at increasing rate.
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MP decreasing, then TP increases at decreasing rate
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MP = 0, then TP is at its maximum.
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MP negative, then TP declines.
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Relationship between Average Product (AP) and Marginal Product (MP)
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MP > AP, AP increases
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MP < AP, AP decreases
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MP = AP, AP is at maximum.
Short-Run Cost
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Total Cost (TC): Cost of all resources used.
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Total Fixed Cost (TFC): Costs of fixed inputs, doesn't change with output.
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Total Variable Cost (TVC): Cost of variable inputs, changes with output.
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TC = TFC + TVC
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Marginal Cost (MC): Increase in total cost that results from a one-unit increase in total product. MC = ∆TC/∆Q
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Average Fixed Cost (AFC): TFC / Q
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Average Variable Cost (AVC): TVC / Q
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Average Total Cost (ATC): TC / Q or AFC + AVC
Short-Run Cost: Relationship between cost curves and product curves
Long-Run Cost
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All inputs are variable in the long run.
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The behavior of long-run cost depends on the production function.
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Production Function: Relationship between maximum output attainable and the quantity of both capital and labor.
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Diminishing Marginal Product of Capital refers to output rising less as capital rises.
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The firm's production function exhibits diminishing marginal returns to labor and capital.
Long-Run Cost: Short-run Cost and Long-Run Cost
- The average cost of producing a given output varies depending on the plant size.
- The larger the plant, the greater is the output at which ATC is at minimum.
Long-Run Cost: Economies and Diseconomies of Scale
- Economies of scale: Input increases greater than output increase, meaning unit costs fall.
- Diseconomies of scale: Input percentage increase is less than output percentage increase, meaning costs rise
- Constant Returns to Scale: Input and output change by the same percentage, keeping unit costs constant.
- Minimum efficient scale (MES): Smallest quantity of output at which long-run average cost reaches the lowest.
Long-Run Cost: Why Economies of Scale?
- Growing firms offer greater employee specialization opportunities.
- Larger firms can take advantage of highly efficient mass production and equipment, spreading setup costs over a large number of units.
Long-Run Cost: Why Diseconomies of Scale?
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In large firms, managers can struggle with coordinating activities, communicating directions effectively, and monitoring personnel.
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Minimum Efficient Scale: The minimum quantity of output where the long-run average cost (LRAC) reaches its lowest level.
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Description
Test your knowledge on the concepts of economic profit, explicit and implicit costs, and production factors. This quiz covers important principles in economics, including the relationship between total and marginal products and the implications of varying production inputs. Perfect for students studying economic principles or professionals looking to refresh their understanding.
