Chapter 8:
.
1 Explain two efficiency concepts: technical efficiency and economic
efficiency.
2 Define and give examples of three types of inputs used in production:
variable
inputs, fixed inputs
3 Explain the difference between long-run and short-run production time
periods.
4 Explain why sunk costs in production differ from avoidable costs.
5 Distinguish between variable proportions production and fixed proportions
production.
6 Compute average product (AP) and marginal product (MP) and explain the
relation among total, average, and marginal products.
7. Define and explain the law of diminishing marginal product.
8 Define total fixed cost (TFC), total variable cost (TVC), total
cost (TC), and short-run draw graphs of average fixed cost (AFC), average
variable cost
(AVC), and average total cost (ATC).
10 Relate short-run costs to the production function using the relations
between (i)
average variable cost and average product, and (ii) short-run marginal cost
and
marginal product.
Essential Concepts
1. A production function shows the maximum amount of output that can be
produced
from any specified set of inputs, given the existing technology.
2. Technical efficiency is achieved when the maximum possible amount of
output is
being produced with a given combination of inputs. Economic efficiency is
achieved when the firm is producing a given amount of output at the lowest
possible total cost.
3. Production inputs can be either variable or fixed:
(a) variable input: an input for which the level of usage may be readily varied
in
order to change the level output. Payments for variable inputs are called
variable costs. Examples of variable inputs are labor, raw materials, and
energy.
(b) fixed input: an input for which the level of usage cannot be readily
changed
and which must be paid even if no output is produced. Payments for fixed
inputs are called fixed costs. Examples of fixed inputs are buildings and other
inputs that a firm leases and capital equipment that cannot be readily varied
with changes in output.
5. The short run refers to a time span during which the firm employs at least
one
fixed input, which, by definition, must be paid even when output is zero in the
short run. In the short run, quasi-fixed inputs may or may not be employed
6. The long run, also called the firm’s planning horizon, refers to the time
period just
far enough in the future to allow all fixed inputs to become variable inputs.
For any
quasi-fixed inputs that might be needed, their levels are fixed in the long run
at
whatever lump amount is required.
7. A sunk cost of production is a payment for an input that, once made,
cannot be
recovered should the manager no longer wish to employ the input. Sunk
input
costs should be ignored for decision making purposes because sunk costs are
not
part of the economic cost of production. Once the sunk payment is made, the
economic (opportunity) cost of using the input thereafter is zero.
8. In contrast to a sunk cost of production, an avoidable cost of production is
a
payment for an input that a firm can recover or avoid paying should the
manager
no longer wish to employ the input. Avoidable costs do matter in decision
making
and should not be ignored. Avoidable costs reflect the opportunity costs of
resource use.
9. Average product of labor ( AP Q/ L ) and marginal product of labor
are related in the following way:
When AP is rising (falling), MP is greater (less) than AP. When AP reaches
its maximum value, AP = MP.
10. The law of diminishing marginal product states that as the usage of a
variable input
increases, a point is reached beyond which its marginal product decreases.
Short-run total cost (TC) is the sum of total variable cost (TVC) and total fixed
cost
(TFC):
TC = TVC + TFC
Average fixed cost (AFC) is equal to total fixed cost divided by output:
Average variable cost (AVC) is equal to total variable cost divided by output:
Average total cost is equal to total cost divided by output or the sum of
average
variable and average fixed cost:
Short-run marginal cost (SMC) measures the rate of change in TC as output
varies