Economics Chapter 9: Theory of the Firm 2

A production function where output increases less than proportionally when all inputs are increased by the same multiple.

A production function where output increases proportionally when all inputs are increased by the same multiple.

A production function where output increases more than proportionally when all inputs are increased by the same multiple.

The rate at which output changes when only input 1 is increased, while holding other inputs constant.

The rate at which output changes when only input 2 is increased, while holding other inputs constant.

The rate at which one input can be substituted for another while keeping output constant.

A production function where output is a power function of inputs.

Determined by the sum of exponents (α + β) in a Cobb-Douglas function:

A legal process that allows a firm to temporarily protect itself from creditors and renegotiate debts, potentially modifying costly contracts like union agreements.

A period of time sufficient for a firm to adjust all its costs, including variable and fixed inputs.

A relationship that shows the maximum output a firm can produce given various combinations of inputs.

A specific combination of inputs used to produce a certain level of output.

A production technique where no other technique produces the same output using fewer inputs, or the same inputs using less of a particular resource.

A less efficient way to produce output, where another technique yields the same output using fewer inputs or the same amount, but a less quantity of one resource.

Resources used in the production process (e.g., workers, raw materials).

The notion that long-run analysis is ultimately irrelevant in analyzing economic trends, as all individuals will eventually experience some sort of financial constraint.

Isoquants are downward sloping because as you use more of one input, you need less of the other to maintain the same level of output. This reflects the idea of substituting inputs.

Isoquants are convex, meaning that the slope gets flatter as you move along the curve. This happens because inputs are more easily substitutable when you have more of one and less of the other.

Convexity is plausible because firms can combine different production techniques at different levels. They can use combinations of inputs, which would be impossible with non-convex isoquants.

The TRS equals the ratio of the marginal product of the input on the horizontal axis to the marginal product of the input on the vertical axis. This means the TRS reflects the relative productivity of each input.

Non-convex isoquants would mean firms would always choose to use either only one input or the other, never combining them. This is not realistic as firms use multiple inputs together.

The TRS tells us how much of one input we need to replace with another to keep output constant. A high TRS means it's easy to substitute between inputs.

Isoquants represent all possible combinations of inputs that produce a given level of output. Points on the isoquant are efficient as they use the least amount of inputs for a given output.

A line representing all possible combinations of inputs that a firm can purchase for a given total cost.

A curve representing all possible combinations of inputs that produce a specific level of output.

The process of finding the least costly input combination for a given level of output.

When the slope of the isoquant equals the slope of the isocost line. This occurs at the point of cost minimization.

The ratio of input prices, w1/w2, in absolute value.

The Technical Rate of Substitution (TRS) equals the ratio of input prices (w1/w2).

Both conditions require the slope of the indifference curve or isoquant to equal the relative prices (p1/p2 or w1/w2).

The goal of every firm - to achieve the highest possible profit. To do this, they need to minimize their expenses (costs) and maximize their revenue.

A set of quantities of two different inputs (like labor and capital) that a firm uses to produce a specific level of output.

Cost minimization is a crucial step towards profit maximization. If the company isn't minimizing the cost of producing its goods, profits will be lower than they could be.

This point represents the cost-minimizing combination of inputs for a given level of output. At this tangency, the slope of the isoquant (the marginal rate of technical substitution, or MRS) equals the slope of the isocost line (the ratio of input prices).

Cost minimization is essential for surviving and thriving in a competitive market. If a firm can produce goods at a lower cost than its competitors, it can either sell them at a lower price (gaining market share) or earn higher profits at the same price.

The firm's profit potential is reduced. They are likely to be less competitive in the market. They might even lose money if their costs exceed their revenue.

When a firm experiences decreasing returns to scale, its total cost curve is convex. This means that as output increases, the cost of producing each additional unit (marginal cost) is greater than the average cost of producing all units.

When a firm experiences increasing returns to scale, its total cost curve is concave. This means that as output increases, the cost of producing each additional unit (marginal cost) is less than the average cost of producing all units.

The relationship between marginal cost (MC) and average cost (AC) depends on the returns to scale. In decreasing returns, MC is always greater than AC. In increasing returns, MC is always less than AC.

The shape of the total cost curve reflects the type of returns to scale. Convexity indicates decreasing returns, concavity indicates increasing returns, and a straight line indicates constant returns.

With constant returns to scale, the total cost curve is a straight line. This means that the cost of producing each additional unit (marginal cost) is equal to the average cost of producing all units.

The production function's returns to scale determine the relationship between output and total cost. Increasing returns lead to lower average cost per unit, while decreasing returns lead to higher average cost per unit.

The total cost curve reflects the firm's production function. When the production function exhibits increasing returns to scale, the total cost curve will be concave. When the production function exhibits decreasing returns to scale, the total cost curve will be convex.

If marginal cost is below average cost, it means that the additional unit is cheaper to produce than the average of all units, which pulls average cost down. If marginal cost is above average cost, it means that the additional unit is more expensive to produce than the average of all units, which pulls average cost up.