Principles of Microeconomics, Econ 1021A, Lecture 9

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Questions and Answers

What is considered the opportunity cost of the owner's labor?

The wage in the next best alternative job (correct)

The profit from selling the product

The wages received from the current job

The materials used in production

Which of the following accurately describes economic depreciation?

The interest earned from lending capital to another party

The measurable change in the capital's quality over time (correct)

An increase in the market value of capital during use

The total cost of acquiring new capital every year

In the short run, which of the following resources is fixed?

Capital stock (correct)

Labor input

Production workers

Raw materials

What distinguishes short-run decisions from long-run decisions?

The flexibility of inputs Signup and view all the answers

What represents the implicit rental rate of capital for a firm that owns its capital?

Forgone rents on capital that could be sold or rented Signup and view all the answers

Which of the following is true regarding short-run decisions?

They do not affect future market options. Signup and view all the answers

What characterizes long-run decisions compared to short-run decisions?

They involve adjustable quantities of all resources. Signup and view all the answers

Which of the following accurately describes a sunk cost?

An expense with no impact on current decisions. Signup and view all the answers

What is an example of the sunk cost fallacy?

Deciding to leave a movie you paid for because it is uninteresting. Signup and view all the answers

Why are sunk costs considered irrelevant to current decision-making?

They cannot be recovered and do not influence future actions. Signup and view all the answers

What is the key difference between accounting profit and economic profit?

Accounting profit only considers measured costs. Signup and view all the answers

Which scenario represents an opportunity cost for a firm?

The best alternative use of resources that are utilized. Signup and view all the answers

What assumption is critical to predicting firm behavior?

Firms maximize profit and minimize costs. Signup and view all the answers

Which of the following elements is considered a component of economic costs?

Potential income lost from an alternative investment. Signup and view all the answers

In economic terms, what is a firm primarily concerned with?

Maximizing profit while minimizing costs. Signup and view all the answers

Which of the following is NOT a type of cost considered in a firm's economic profit?

Market research expenses. Signup and view all the answers

What does a firm's opportunity cost of production include?

Costs of resources bought in the market. Signup and view all the answers

Which economic concept emphasizes the importance of understanding different cost structures over time?

Long-run costs associated with scaling. Signup and view all the answers

What happens to the total product as the quantity of labour employed increases?

Total product increases. Signup and view all the answers

What is the marginal product of labour?

The change in total product from a one-unit increase in the quantity of labour employed. Signup and view all the answers

Which of the following correctly describes the average product of labour?

It is equal to the total output divided by the number of workers employed. Signup and view all the answers

In the short-run, increasing output primarily requires adjustments in which input?

Labour. Signup and view all the answers

What was one of the main reasons for the continued funding of the Concorde project?

The original economic case was no longer valid. Signup and view all the answers

What represents the marginal cost in production?

Increase in total cost from a one-unit increase in output Signup and view all the answers

What happens to average cost as output increases?

It decreases then increases Signup and view all the answers

What is the primary reason for the U-shape of the average variable cost curve?

Diminishing marginal product of labor Signup and view all the answers

How is total cost defined in production?

Sum of total fixed cost and total variable cost Signup and view all the answers

Which of the following correctly describes the relationship between marginal product and average product?

When MP exceeds AP, AP is increasing Signup and view all the answers

What describes the concept of diminishing marginal returns?

Adding more inputs leads to a smaller increase in output Signup and view all the answers

What does the total product curve represent in economic terms?

The relationship between input and output levels Signup and view all the answers

In which scenario would marginal cost begin to rise?

When diminishing marginal returns set in Signup and view all the answers

What contributes to the shape of the average total cost curve?

Both diminishing marginal product and the spreading of fixed costs Signup and view all the answers

What is the role of total fixed cost in short-run production?

They remain constant regardless of output level Signup and view all the answers

What is the effect of increasing production on average fixed cost?

Average fixed cost decreases Signup and view all the answers

What defines the short-run in production economics?

At least one input is fixed Signup and view all the answers

What is indicated by a higher total product at low output levels?

Increasing marginal returns to labor Signup and view all the answers

What is average product calculated from?

Total product divided by quantity of labor Signup and view all the answers

Which input price change affects the marginal cost curve?

Increased price of variable inputs Signup and view all the answers

What happens to all curves when there is an increase in productivity due to technological change?

All cost curves shift downward Signup and view all the answers

How do long-run costs differ from short-run costs?

All inputs are variable Signup and view all the answers

What happens when a firm experiences diminishing marginal returns to labor?

The additional output gained from each worker decreases Signup and view all the answers

In choosing capital to minimize costs in the long run, which element is NOT considered?

Profit margins from production Signup and view all the answers

When a firm installs more capital, what trade-off is it facing?

Increased fixed costs for decreased variable costs Signup and view all the answers

What does the marginal product of capital indicate?

Output increase from one additional unit of capital, holding labor constant Signup and view all the answers

Which of the following best describes long-run average total cost curves?

They trace minimum of short-run average total cost curves Signup and view all the answers

What occurs when a firm increases fixed inputs while reducing variable inputs?

Fixed costs increase while variable costs decrease Signup and view all the answers

Which statement about the production function is correct?

It provides output levels from specific input combinations Signup and view all the answers

What will happen if a firm's capital decisions lead to a higher average total cost?

The firm could consider restructuring its capital investment Signup and view all the answers

How does an increase in fixed input prices affect total cost and average total cost curves?

Both curves shift upward but not marginal cost Signup and view all the answers

What is a possible outcome of diminishing marginal returns in the production process?

Reduction in productivity per additional unit of labor or capital Signup and view all the answers

In the context of long-run planning, what is essential to minimizing costs?

Choosing plant size based on expected output quantity Signup and view all the answers

Study Notes

Principles of Microeconomics, Economics 1021A, Lecture 9: Output and Cost

The lecture covers output and cost, time frames (short-run and long-run), and firm behaviour.
Key topics include distinguishing economic and accounting definitions of costs and profits, explaining and differentiating short- and long-run cost schedules, and discussing the economic significance of understanding production costs.
Firms are institutions that hire factors of production to produce and sell goods/services.
The goal is to predict firm behaviour, based on the assumption that firms maximize profit and minimize costs.

Profit

Profit is revenue minus cost.
Two types of profit are:
- Accounting profit: Total revenue minus accounting cost.
- Economic profit: Total revenue minus total economic cost.
Accounting profit ignores opportunity cost.
Economic profit includes opportunity cost.

Firm Opportunity Costs

Opportunity cost of production is the value of the best alternative use of resources.
It is the total economic cost of using resources, whether:
- Bought in the market (includes raw materials, employee wages, leased capital, financing costs).
- Supplied by the firm's owner (entrepreneurship, labor).
- Owned by the firm (capital - economic depreciation, interest forgone, implicit rental rate).

Short-run and Long-run

Short-run and long-run are not precise measures of time.
The key distinction in decisions is what is fixed versus what's flexible.
What's fixed does not change during that time period.
What's flexible can be adjusted.
Persistence of decision's consequences.

Short-run

The quantity of one or more resources used in production (e.g., capital stock) is fixed in the short run.
Variable inputs (e.g., labor, raw materials, energy) are adjustable in the short run.
The quantity of capital is not adjustable in the short run.
Short-run decisions don't affect future options.
A firm cannot immediately sell, buy, or exit/enter a market in the short run.

Long-run

All quantities of resources, including capital stock and plant size, are adjustable in the long run.
Long-run decisions affect future options and can be sunk costs.
Sunk costs are costs incurred in the past that cannot be recovered.
Sunk costs are irrelevant to current decisions.

Short-run Output

Total Product (TP): total output produced in a given period.
Marginal Product (MP) of labor: change in total product from a 1-unit increase in the quantity of labor employed, with all other inputs remaining the same.
Average Product (AP) of labor: output per unit of labor employed (total output divided by the quantity of labor).

Short-run Cost

Total cost (TC) = economic cost of all inputs used to produce a given amount of output.
Marginal cost (MC) is the increase in total cost from a one-unit increase in output.
Average cost (AC) is cost per unit of output (total cost divided by total product).

Short-run Total cost: Breakdown

Total cost (TC) is the sum of total fixed cost (TFC) and total variable cost (TVC).
Total fixed cost (TFC) does not change with output.
Total variable cost (TVC) increases with output.

Cost Curves Reflect Output Curves

Total product is steeper at low output and flatter at high output because of diminishing marginal product.
Variable cost is the wage multiplied by the quantity of labor.
Variable cost increases as labor requirements grow.

Short-run Cost Curves

Cost curves plot costs against output quantities.
To get cost on the y-axis, flip the last slide's TVC graph and reinsert the total fixed cost.
Add up the curves to find a convex total cost curve.

Marginal Cost

Marginal cost (MC): increase in total cost resulting from a one-unit increase in total product.
Over the increasing marginal product range, marginal cost falls as output increases.
Over the diminishing marginal product range, marginal cost rises as output increases.

Average Cost

Average cost measures costs per unit of output produced.
Types of average cost:
- Average fixed cost (AFC).
- Average variable cost (AVC).
- Average total cost (ATC).
ATC = AFC + AVC = (TFC + TVC)/Q

Average Cost Curve Shapes

As output increases, average fixed cost (AFC) decreases.
But average variable cost (AVC) initially falls and then increases.

U-shaped Average Variable Cost

AVC curve is U-shaped because marginal product declines.
Initially, marginal worker is more productive than average.
The incremental cost of output is lower than average variable cost, and AVC falls.
Eventually, marginal worker is less productive than average.
The incremental cost of output is higher than average variable cost, and AVC rises.

U-shaped Average Total Cost

The ATC curve is U-shaped for two reasons:
- Diminishing marginal product and U-shaped average variable cost.
- Spreading fixed costs across larger output (so AFC falls as output grows).

Cost Curve Shifts

Technology shifts both product and cost curves. Increased productivity shifts cost curves downward.
Prices of factors of production shift cost curves: higher fixed costs shift the total and ATC curves upward; higher variable costs shift all three cost curves upward.

Long-run Cost

In the long run, all inputs are variable.
The production function is very important for understanding long-run cost behavior.
A firm's production function (e.g. for sweaters) relates capital inputs and labor inputs to output.
A firm can choose among different plants/amounts of capital with distinct short-run cost curves.
LRATC: long-run average total cost; the lowest average cost across all different levels of capital.

Scale Economies

Economies and diseconomies of scale affect production decisions, the market structure, and supply curves.
Economies of scale: long-run average costs drop as output increases.
Diseconomies of scale: long-run average costs rise as output increases.
Constant returns to scale: long-run average costs remain constant as output increases. (This occurs where the effect of economies and diseconomies balance out).

Minimum Efficient Scale

The minimum efficient scale is the smallest quantity of output that minimizes long-run average costs.

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Description

This quiz covers key concepts from Lecture 9 of Economics 1021A, focusing on output and cost. It highlights firm behaviour, the distinction between accounting and economic profits, and the significance of opportunity costs in production. Prepare to understand how these elements influence firms' decision-making.