Production, Productivity & the Firm

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Questions and Answers

Which of the following BEST describes the role of an entrepreneur in the production process?

  • Operating machinery and equipment.
  • Making decisions about what, how, and for whom to produce, as well as bearing financial risk. (correct)
  • Providing the land necessary for production.
  • Supplying capital goods for production.

What distinguishes production from productivity?

  • Production refers to the total output, while productivity is the efficiency of output per unit of input. (correct)
  • There is effectively no difference between production and productivity.
  • Production involves capital goods, while productivity involves labor.
  • Production is output per worker, while productivity is the conversion of inputs into outputs.

If a country is experiencing a 'productivity puzzle,' what does this generally indicate?

  • The country's production levels are higher than its consumption levels.
  • The country's labour productivity has failed to recover to pre-recession levels, lagging behind competitor countries. (correct)
  • The country has a shortage of entrepreneurs and innovative ideas.
  • The country is unable to accurately measure its gross domestic product (GDP).

What is a primary characteristic of a 'flexible' labor market?

<p>Workers' ability to quickly adapt to changes in the demand and supply conditions. (C)</p> Signup and view all the answers

According to Ronald Coase, what is the main reason for the existence of firms?

<p>To reduce transaction costs, such as search and information costs. (C)</p> Signup and view all the answers

What is the key requirement for successful barter to occur?

<p>A 'double coincidence of wants'. (A)</p> Signup and view all the answers

How does the use of money improve economic efficiency compared to barter?

<p>Money eliminates the need for a double coincidence of wants. (B)</p> Signup and view all the answers

What is 'capital widening'?

<p>Employing 'more of the same' capital. (C)</p> Signup and view all the answers

What is the defining characteristic of the 'short run' in microeconomic theory?

<p>At least one factor of production is fixed. (C)</p> Signup and view all the answers

According to the law of diminishing returns, what eventually happens as a variable factor is added to a fixed factor of production?

<p>Marginal and average returns of the variable factor begin to fall. (A)</p> Signup and view all the answers

If the marginal returns of labor are greater than the average returns of labor, what will happen to the average returns?

<p>The average returns will rise. (C)</p> Signup and view all the answers

What are 'returns to scale'?

<p>The rate by which output changes if the scale of all factors of production is changed. (C)</p> Signup and view all the answers

What are increasing returns to scale?

<p>When output increases at a faster rate than the increase in inputs. (C)</p> Signup and view all the answers

What are 'fixed costs'?

<p>Costs that do not change with the level of output in the short run. (D)</p> Signup and view all the answers

What is 'marginal cost'?

<p>The addition to total cost resulting from producing one additional unit of output. (B)</p> Signup and view all the answers

How is 'average total cost' (ATC) calculated?

<p>By dividing total cost by the quantity of output. (C)</p> Signup and view all the answers

What typically explains the U-shape of the short-run average total cost (ATC) curve?

<p>Fixed costs initially dominating, then variable costs increasing more rapidly due to diminishing returns. (B)</p> Signup and view all the answers

If wage levels are low but the price of capital is high, what type of production method is a firm most likely to employ, ignoring productivity?

<p>A labour-intensive method. (B)</p> Signup and view all the answers

Besides returns to scale, what other factors can reduce long-run average costs?

<p>Bulk buying. (B)</p> Signup and view all the answers

What are economies of scale?

<p>Falling long-run average costs of production. (D)</p> Signup and view all the answers

What is the distinction between internal and external economies of scale?

<p>Internal economies result from a firm's growth, while external economies result from the growth of the industry or market. (C)</p> Signup and view all the answers

What is an example of a technical economy of scale?

<p>Spreading research and development costs over a longer production run. (A)</p> Signup and view all the answers

What is an example of a marketing economy of scale?

<p>Bulk-buying discounts. (A)</p> Signup and view all the answers

What is an example of a financial economy of scale?

<p>Lower interest rates on loans for large firms. (B)</p> Signup and view all the answers

What is an example of economies of scope?

<p>Businesses sharing centralized functions. (A)</p> Signup and view all the answers

What contributes to managerial diseconomies of scale?

<p>Personnel lacking appropriate experience make bad decisions. (C)</p> Signup and view all the answers

What happens within a firm as communications fail?

<p>There are more layers of management between the top managers and ordinary production workers, and staff can feel remote and unappreciated. (A)</p> Signup and view all the answers

What can happen in a company because of motivational diseconomies of scale?

<p>Workers perform repetitive tasks and have little incentive to use personal initiative in ways which help their employer. (A)</p> Signup and view all the answers

What effect do increasing returns to scale typically have on long-run average costs?

<p>They lead to falling long-run average costs. (A)</p> Signup and view all the answers

What is a common cause of external diseconomies of scale?

<p>Increased competition for labor, raising local wages. (D)</p> Signup and view all the answers

In an LRAC curve skewed to the left, what does this shape imply about economies and diseconomies of scale?

<p>Economies of small-scale production are quickly exhausted, and diseconomies of scale set in early. (A)</p> Signup and view all the answers

When the LRMC curve cuts through the lowest point on a LRAC curve, what shape must the LRAC curve be?

<p>U-shaped, displaying first economies of scale and then diseconomies of scale. (D)</p> Signup and view all the answers

What is the significance of the lowest point on an LRAC curve tangent to an SRAC curve?

<p>It indicates the average cost-minimizing size of the firm. (C)</p> Signup and view all the answers

What describes Long-run marginal cost?

<p>Additional cost incurred if a firm increases output when all the factors of production are variable. (A)</p> Signup and view all the answers

What describes Long-run Marginal Costs vs. Long-run Average Costs

<p>When long-run marginal costs fall and are below long-run average costs, the LRAC curve falls (C)</p> Signup and view all the answers

The large super-tankers that are used to transport crude oil across seas and oceans from oil fields to industrial markets benefit significantly from which?

<p>volume economies of scale. (C)</p> Signup and view all the answers

Flashcards

What is production?

The process of converting inputs (factor services) into outputs (goods and services).

What are factors of production?

Inputs used in the production process: land, labor, capital and enterprise..

What is productivity?

Output per unit of input, commonly measured as output per worker per week.

What is labor productivity?

Output per worker.

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What is capital productivity?

Output per unit of capital.

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What is the productivity gap?

The difference in labor productivity between two economies.

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What is a firm?

A productive organization that sells its output of goods or services commercially.

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What is Specialization?

A worker performs only one task or a narrow range of tasks

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What is division of labor?

Different workers performing different tasks in the course of producing a good or service.

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What is Trade?

The buying and selling of goods and/or services.

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What is Exchange?

To give something in return for something else received. Money is a medium.

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What is the Short Run?

The period where at least one factor of production is fixed

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What is the Long Run?

The period in which all factors of production can be changed

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What is the Law of Diminishing Returns?

As a variable factor is added to a fixed factor, eventually the marginal and average returns to the variable factor begin to fall.

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What are Marginal Returns of Labor?

The change in total output resulting from employing one more worker.

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What are Total Returns?

Total output produced by all factors of production, including labor.

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What are Average Returns of Labor?

Total output divided by the total number of workers employed.

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What are Returns to Scale?

The rate by which output changes if the scale of all factors of production is changed.

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What is a Plant?

An establishment such as a factory, workshop, or retail outlet, owned and operated by a firm.

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What are Increasing Returns to Scale?

When the scale of all factors increases and output increases at a faster rate.

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What are Constant Returns to Scale?

When the scale of all factors increases and output increases at the same rate.

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What are Decreasing Returns to Scale?

When the scale of all factors increases and output increases at a slower rate.

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What is a Fixed Cost?

A cost that, in the short run, does not change with output.

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What is a Variable Cost?

A cost that changes with the amount produced, even in the short run.

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What is Total Cost?

All costs incurred when producing a particular size of output.

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What is Average Variable Cost?

Total variable cost divided by the size of output.

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What is Marginal Cost?

Addition to total cost resulting from producing one additional unit of output.

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What is Average Fixed Cost?

Total cost of employing fixed factors divided by size of output.

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What is Average Total Cost?

Total cost of producing a particular level of output, divided by the size of output.

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What are Economies of Scale?

As output increases, long-run average cost falls.

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What are Diseconomies of Scale?

As output increases, long-run average cost rises.

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What are Internal Economies/Diseconomies of Scale?

Changes in long-run average costs resulting from changes in the size or scale of a firm or plant.

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What is an External Economy of Scale?

A fall in long-run average costs resulting from the growth of the market or industry.

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What is an External Diseconomy of Scale?

An increase in long-run average costs resulting from the growth of the market or industry.

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Study Notes

  • Production: Converts inputs into outputs of goods/services
  • Factors of production: Land, labor, capital, and enterprise (entrepreneurial input)
  • Entrepreneurs: Decision-makers and financial risk-takers, rewarded with profit

Production vs. Productivity

  • Production: The process of converting inputs into outputs
  • Productivity: Output per unit of input
  • Labour productivity is output per worker, essential for international competitiveness

Significance of Productivity

  • UK's "productivity puzzle": Labour productivity failed to recover post-2009 recession
  • Possible reasons for productivity puzzle: Underinvestment in capital, low wages, labor hoarding during recession
  • Consequences of productivity puzzle: Demands for sacrifices from workers or boosting productivity through investment

The Firm

  • Firm: A commercial business that produces or exchanges goods/services for revenue
  • Firms reduce transaction costs (search, information, bargaining)

Specialisation and Division of Labour

  • Specialisation: Workers focus on specific tasks
  • Division of labour: Different workers perform different tasks in producing a good/service
  • Benefits of specialisation: Time-saving, allows better machinery, workers become more efficient
  • Trade and exchange enables specialisation

Trade and Exchange

  • Barter requires a "double coincidence of wants"
  • Money facilitates trade and specialisation
  • Shift toward a cashless society

Short Run vs. Long Run

  • Short run: At least one factor of production is fixed
  • Long run: All factors of production can be varied

The Law of Diminishing Returns

  • As a variable factor is added to a fixed factor, marginal and average returns eventually fall
  • Increasing marginal returns occur initially with a small labor force
  • Diminishing marginal returns set in as labor is added to fixed capital

Returns to Scale

  • Returns to scale: How output changes when the scale of all factors changes
  • Occurs in the long run
  • Increasing returns to scale: Output increases more than proportionately
  • Constant returns to scale: Output increases proportionately
  • Decreasing returns to scale: Output increases less than proportionately

Short-Run Costs

  • Total Cost (TC) = Total Fixed Cost (TFC) + Total Variable Cost (TVC)
  • Average Total Cost (ATC) = Average Fixed Cost (AFC) + Average Variable Cost (AVC)
  • Long-run costs are always variable

Types of Costs

  • Fixed costs: Do not change with output in the short run
  • Variable costs: Change with output
  • Average cost (unit cost): Total cost divided by output
  • Marginal cost: Addition to total cost from producing one more unit

Average Fixed Cost (AFC) Curve

  • AFC curves slope downwards as overheads are spread over larger output

Average Total Cost (ATC) Curve

  • ATC curve is U-shaped, combining AFC and AVC

Factor Prices and Productivity

  • Firms aim to maximize profit at the lowest cost
  • Optimal factor combination considers factor prices and productivity
  • Low wages + high capital price can be attractive to employ labor
  • High wages + cheap capital, cost minimisation is likely to require a capital-intensive method of production

Economies and Diseconomies of Scale

  • Economies of scale: Falling long-run average costs as output increases
  • Diseconomies of scale: Rising long-run average costs
  • Internal economies/diseconomies: Result from changes within the firm
  • External economies/diseconomies: Result from changes in the industry/market

Internal Economies of Scale

  • Technical: Indivisibilities, R&D spreading, volume economies, massed resources, vertically linked processes
  • Managerial: Specialisation within management
  • Marketing: Bulk-buying and bulk-marketing
  • Financial: Better borrowing terms for large firms
  • Risk-bearing: Spreading risks through diversification
  • Economies of scope: Sharing centralized functions

Internal Diseconomies of Scale

  • Managerial: Administration issues, delegation to inexperienced personnel
  • Communication failure: Too many management layers
  • Motivational: Overspecialisation, repetitive tasks

Returns to Scale Relationship with Economies/Diseconomies

  • Increasing returns to scale leads to economies of scale (falling LRAC)
  • Decreasing returns to scale leads to diseconomies of scale (rising LRAC)
  • LRAC curves can be symmetrical U-shape or other shapes (horizontal, skewed to the left, skewed to the right)
  • LRMC shows additional cost incurred if a firm increases output when all factors are variable
  • Average cost-minimising size of firm occurs at the lowest point on the LRAC curve
  • External economies of scale occur when a firm’s average costs of production fall because of the growth of the market or industry
  • External diseconomies of scale occur when the growth of the market raises the average costs of the firms in the industry

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