The Production Function
What is the definition of the production function?
It shows the relationship between inputs and output in the production process.
What is the key difference between the short run and the long run in production?
In the short run, at least one input is fixed; in the long run, all inputs are variable.
What rule do firms follow to maximize profit?
They produce where MR = MC.
What condition must be met for a firm to earn a profit in the short run?
The firm earns a profit when P > ATC, meaning the price is higher than the average total cost per unit.
What are the four characteristics of perfect competition?
Many buyers and sellers, identical products, no barriers to entry, and price-taking firms.
What is the difference between total product and marginal product?
Total product is the total output produced, while marginal product is the additional output from adding one more unit of input.
What is the formula for average total cost (ATC)?
ATC = Total Cost / Quantity or ATC = AFC + AVC.
If total revenue is $500 and total cost is $400, what is the firm’s profit?
Profit = $100.
What is the break-even price for a firm?
The break-even price is where P = ATC, meaning the firm earns zero economic profit (normal profit).
Why do firms in perfect competition earn zero economic profit in the long run?
Entry and exit drive price to the point where P = ATC.
What is the law of diminishing marginal returns?
As more of a variable input is added to a fixed input, the additional output from each new unit of input eventually decreases.
What causes economies of scale in the long run?
Factors like specialization, bulk purchasing, and improved capital efficiency.
What is the difference between accounting profit and economic profit?
Economic profit includes opportunity costs while accounting profit does not.
Where is the shutdown price, and why is it important?
The shutdown price is where P = AVC because if price falls below average variable cost, the firm cannot cover variable costs and should shut down in the short run.
What does the demand curve look like for an individual firm in perfect competition?
Perfectly elastic, a horizontal line at the market price.
If the marginal product of labor is increasing, what happens to the total product curve?
It increases at an increasing rate.
What happens to marginal cost (MC) when the marginal product (MP) increases?
MC decreases.
How does a firm know whether to shut down in the short run?
If P < AVC, the firm should shut down.
How do you identify profit or loss on a cost curve graph?
Profit is the area between P and ATC when P > ATC, while loss is the area between ATC and P when P < ATC but P > AVC (firm stays open)
Why can’t a perfectly competitive firm influence the market price?
Because there are many firms, each producing an identical product.
What is the formula for the marginal product of labour?
MP = ΔTP / ΔL, where TP = total product and Q = labour.
Why does the long-run average total cost (LRATC) curve have a U-shape?
It initially declines due to economies of scale, flattens, and then increases due to diseconomies of scale.
What happens to total revenue if a perfectly competitive firm increases its price above the market equilibrium?
Total revenue drops to zero because no one buys from them.
What is the short-run supply curve of a firm?
It is the MC curve above AVC because firms only produce when P ≥ AVC; otherwise, they shut down.
What happens to a perfectly competitive firm’s output and profit if there is a temporary increase in market demand?
In the short run, the market price rises, leading to higher output and positive economic profit for firms. However, in the long run, new firms enter the market, increasing supply and driving price and profit back to zero economic profit (P = ATC)