CA 2 economics

• Theory of Production involves the process of transforming both fixed and variable inputs into finished goods and services
• Enterprise refers to a single production activity
• Production Function is the technical relationship between the quantity of inputs used to produce a good and the quantity of output of that good
• Inputs (factors of production):

  • Fixed inputs: whose use rate does not change as the output level changes
  • Variable inputs: whose use rate changes as the output level changes
• Outputs are goods and services produced using the inputs
• Total Product (TP/Qty) is the total amount of output produced in physical units
• Marginal Product (MP) is the rate of change in output as an input is changed by 1 unit (ceteris paribus)
• Law of diminishing returns states that when successive units of a variable input work with a fixed input, beyond a certain point the additional product produced by each additional unit of a variable input decreases
• Average Product measures the total output per unit of input used; expresses the "productivity of an input; associated with efficiency; AP = Qty / Input
• Length of Run:

  • Long run: all inputs to the production function can be treated as variable
  • Short run: period of time short enough that some inputs can be treated as fixed
  • Very short run: so short that none of the inputs are variable
• Returns to Scale:

  • Constant returns to scale: as all inputs are increased by a given proportion, output increases by the same proportion
  • Increasing returns to scale: as all inputs are increased by a given proportion, output increases by a greater proportion
  • Decreasing returns to scale: as all inputs are increased by a given proportion, output increases by a lesser proportion
• Profit is the difference between total revenue and total cost

  • Total revenue: the amount a firm receives from the sale of its output
  • Total cost: the market value of the inputs a firm uses in production
  • Types of profit:
  • Accounting profit: total revenue minus total explicit costs; higher than economic profit
  • Economic profit: total revenue minus total costs (explicit + implicit costs)
• Factors of production:

  • Land: everything above and beneath the land surface; payment is rent
  • Labor: the physical and mental effort exerted in the production of products; payment is wages
  • Capital: finished products that are used to produce other products; payment is interest
  • Entrepreneur/management: one who organizes the other resources (land, labor, and capital); payment is profit
• Theory of Costs:

  • Short run costs: costs over a period during which some factors of production are fixed
  • Long-run costs: costs over a period long enough to permit the change of all factors of production; all factors are variable
• Total fixed cost (TFC) refers to "sunk cost" or "overhead costs" that do not vary with output
• Total variable costs (TVC) are costs that do vary with output, also called direct costs
• Total cost (TC) is made up of total fixed and variable costs (TC = TFC + TVC)
• Average costs:

  • Average fixed costs (AFC) = TFC/TP
  • Average variable costs (AVC) = TVC/TP
  • Average total costs (ATC) = TC/TP
• Theory of Production:

  • Process of transforming both fixed and variable inputs into finished goods and services
• Enterprise:

  • Refers to a single production activity
• Production Function:

  • The technical relationship between the quantity of inputs used to produce a good and the quantity of output of that good
  • Can be represented by a table, equation, or graph
• Inputs (factors of production):

  • Fixed inputs: inputs whose use rate does not change as the output level changes
  • Variable inputs: inputs whose use rate changes as the output level changes
• Outputs:

  • Goods and services produced using the inputs
• Total Product (TP/Qty):

  • Total amount of output produced in physical units
• Marginal Product (MP):

  • The rate of change in output as an input is changed by 1 unit (ceteris paribus)
• Law of diminishing returns:

  • States that when successive units of a variable input work with a fixed input, beyond a certain point the additional product produced by each additional unit of a variable input decreases
• Average Product:

  • Measures the total output per unit of input used
  • Expresses the "productivity of an input"
  • Associated with efficiency
  • AP = Qty / Input
• Length of Run:

  • Classification of production processes according to the length of run or time period being considered
  • Long run: all inputs to the production function can be treated as variable
  • Short run: period of time short enough that some inputs can be treated as fixed
  • Very short run: so short that none of the inputs are variable
• Returns to Scale:

  • The quantitative change in output of a firm or industry resulting from a proportionate increase in all inputs
  • Constant returns to scale: as all inputs are increased by a given proportion, output increases by the same proportion
  • Increasing returns to scale: as all inputs are increased by a given proportion, output increases by a greater proportion
  • Decreasing returns to scale: as all inputs are increased by a given proportion, output increases by a lesser proportion
• Profit:

  • The difference between total revenue and total cost
• Total revenue:

  • The amount a firm receives from the sale of its output
• Total cost:

  • The market value of the inputs a firm uses in production
  • Explicit costs: require cash outlay
  • Implicit costs: do not require cash outlay
• Types of Profit:

  • Accounting profit: total revenue minus total explicit costs; ignores implicit costs, thus, higher than economic profit
  • Economic profit: total revenue minus total costs (explicit + implicit costs)
• Factors of production:

  • Land: everything above and beneath the land surface; payment is rent
  • Labor: the physical and mental effort exerted in the production of products; payment is wages
  • Capital: finished products that are used to produce other products; payment is interest
  • Entrepreneur/management: one who organizes the other resources (land, labor, and capital); payment is profit
• Theory of Costs:

  • Short run costs: the costs over a period during which some factors of production are fixed
  • Long-run costs: the costs over a period long enough to permit the change of all factors of production; all factors are variable
• Total fixed cost (TFC):

  • Refers to "sunk cost" or "overhead costs" that do not vary with output and typically include rents, insurance, depreciation, and related costs
• Total variable costs (TVC):

  • Costs that do vary with output, also called direct costs
• Total cost (TC):

  • Made up of total fixed and variable costs (TC = TFC + TVC)
• Average costs:

  • Average fixed costs (AFC) = TFC/TP
  • Average variable costs (AVC) = TVC/TP
  • Average total costs (ATC) = TC/TP