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ECONOMICS. CHAPTER 6
INPUTS & COSTS
Firm: Organization that produces goods or services for sale.
-It transforms INPUTS into OUTPUTS.
THE PRODUCTION FUNCTION.
The production function is the relationship between the quantity of inputs a firm uses and the quantity of outputs it produces.
-FIXED INPUT: Input whose quantity is fixed for a period of time and cannot be varied.
Ex. Land -VARIABLE INPUT: Input whose quantity the firm can vary at any time.
Ex. Labour LONG RUN: Time period in which inputs can be varied.
-There are no fixed inputs in the long run.
SHORT RUN: Time period in which at least one input is fixed.
TOTAL PRODUCT CURVE (TPC): Shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input.
MARGINAL PRODUCT OF LABOR.
The Marginal Product of an input is the additional quantity of output that is produced by using one more unit of that input.
The Marginal Product of Labor is the change in quantity of output generated by adding another additional worker.
There are diminishing returns to an input when an increase in the quantity of that input leads to a decline in the marginal prouct of that input.
-As we add more and more workers eventually we get less and less output.
FROM THE PRODUCTION FUNCTION TO COST CURVES.
Fixed cost: Cost that doesn’t depend on the quantity of output produced.
Variable cost: Cost that depends on the quantity of output produced.
TOTAL COST = FIXED COST + VARIABLE COST Total cost curve: Steeper as more output is produced due to diminishing returns.
ECONOMICS. CHAPTER 6 MARGINAL COST AND AVERAGE COST Marginal cost is the additional cost incurred by producing one more unit.
*As output increases, the marginal product of the variable input declines.
This implies that more and more of the variable input must be used to produce each additional unit of output — The cost per additional unit of output also rises.
AVERAGE TOTAL COST (ATC): Total cost divided by quantity of output produced.
ATC = TC/Q Average fixed cost: Fixed cost per unit of output.
Average variable cost: Variable cost per unit of output.
*Increasing output has two opposing effects: 1.Spreading effect: The larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower the average fixed cost.
2.Diminishing return effect: The larger the output, the greater the amount of variable input required to produce additional units leading to higher average variable cost.
GENERAL PRINCIPLES: 1.Minimum-cost output is the quantity of output at which average total cost is lowest.
-At the minimum-cost output, average total cost is equal to marginal cost.
-At output less than the minimum-cost output, marginal cost is less than average total cost.
-Output greater than the minimum-cost output, marginal cost is greater than average total cost.
SHORT-RUN versus LONG-RUN COSTS.
LONG RUN: All inputs are variable in the long run.
-The firm will choose its fixed cost in the long run based on the level of output it expects to produce.
SHORT RUN: Fixed cost is completely outside the control of a firm.
LONG-RUN AVERAGE TOTAL COST CURVE: shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output.
ECONOMICS. CHAPTER 6 RETURNS TO SCALE.
There are increasing returns to scale when long-run average total cost declines as output increases.
There are decreasing returns to scale when long-run average total cost increases as output increases.
There are constant returns to scale when long-run average total cost is constant as output increases.
Network externalities are when the value of a good to people is greater when more people use it.