1. What are the only costs that influence a firm's current decision-making?

Only the short run costs of changing its labor and the long run costs of changing its plant
influence a firm's current decision-making.

2. Short-Run Technology Constraint

To increase output in the short-run, a firm must increase the quantity of labor employed.

The relationship between output and the quantity of labor is described by 3 related concepts: 1) total
product, 2) marginal product, and 3) average product.

3. Total Product

Total product is the maximum output that a given quantity of labor can produce.

4. Marginal Product

Marginal product of labor is the increase in total product that results from a one-unit increase in
the quantity of labor employed, with all other inputs remaining constant.

5. Average Product
The average product of labor is equal to the total product divided by the quantity of labor
employed, and indicates how productive workers are on average.
6. Increasing Marginal Returns
Increasing marginal returns occur when the marginal product of an additional worker
exceeds the marginal product of the previous worker. Increasing marginal returns arise from
increased specialization and division of labor in the production process.
7. Diminishing Marginal Returns
Diminishing marginal returns occur when the marginal product of an additional worker is less
than the marginal product of the previous worker.
8. Law of Diminishing Marginal Returns
The law of diminishing marginal returns states that as a firm uses more of a variable factor of
production with a given quantity of the fixed factor of production, the marginal product of
the variable factor eventually diminishes.
9. Total Cost (TC) A firm's total cost is the cost of all the factors of production it uses. We
separate total cost into total fixed cost and total variable cost.
10. Total Fixed Cost (TFC) Total fixed cost is the cost of the firm's fixed factors.

**NOTE: The quantities of fixed factors (capital, normal profit) do NOT change as output
changes, so total fixed cost is the same at all outputs.*

Total Variable Cost (TVC) Total variable cost is the cost of the firm's variable factors.

**NOTE: Total variable cost changes as output changes.**

Marginal Cost (MC)

11. At what outputs does marginal cost decrease? At small outputs, marginal cost decreases as
output increases because of greater specialization and the division of labor.
12. Average Fixed Cost (AFC) Average fixed cost is the total cost per unit of output.
13. Average Variable Cost (AVC) Average variable cost is the total variable cost per unit of
output.
14. Average Total Cost (ATC) Average total cost is the total cost per unit of output.
15. Production Function The production function is the relationship between the maximum
output attainable and the quantities of both labor and capital.
16. Marginal Product of Capital The marginal product of capital is the change in the total product
divided by the change in capital when the quantity of labor is constant.

Equivalently, the marginal product of capital is the change in output resulting from a one-unit
increase in the quantity of capital.
17. Long-Run Average Cost Curve The long-run average cost curve is what firms operate
on when they produce a given output at the least possible cost. The long-run
average cost curve should minimize average total cost.

**The long-run average cost curve is the relationship between the lowest
attainable average total cost and output when the firm can change both the
plant it uses and the quantity of labor it employs.**

The LRAC curve is made up of the lowest pieces of however many ATC curves
are in a firm's plans.

Economies of Scale Economies of scale are features of a firm's technology that make
average total cost FALL as output increases. When economies of scale are present,
the LRAC curve slopes downward.

Greater specialization of both LABOR and CAPITAL is the main source of economies of
scale.

18. Diseconomies of Scale Diseconomies of scale are features of firm's technology that make
average total cost RISE as output increases. When diseconomies of scale are present, the
LRAC curve slopes upward.
19. Constant Returns to Scale Constant returns to scale are features of a firm's technology that
keeps average total cost constant as output increases. When constant returns to scale are
present, the LRAC curve is horizontal.
20. Minimum Efficient Scale
A firm's minimum efficient scale is the smallest output at which long-run average cost
reaches its lowest level. Graphically, the minimum efficient scale is the lowest point on the
long-run average cost curve.

The minimum efficient scale plays a role in determining market structure. In a market in
 which the minimum efficient scale is small relative to market demand, the market has room
for many firms, and is competitive. In a market in which the minimum efficient scale is large
relative to market demand, only a small number of firms can make a profit.
21. What is the entrepreneur's biggest decision? Which industry to establish a firm. (Often
driven by passion and background knowledge/interest, can also be where there is expected
economic profit)
22. What is the short run time frame? When the quantity of at least one factor of production is
fixed.
23. What is the plant? The fixed factors of production. In the short run it is fixed.
24. What is the long run time frame? All factors of production can be variable. Firm can change
its plant.
25. What is a sunk cost? Past expenditure on a plant that has no resale value. Irrelevant to a
firm's current decisions.
26. What points are efficient? (Product Curve) Only points on the total product curve are
technologically efficient.
27. What are the two features of most product curves? 1) Increasing marginal returns initially
(most) 2) Decreasing marginal returns eventually (all)
28. Increased marginal returns occurs because of? ( 1) Increased specialization (2) Division of
labour in the production process.
29. When does diminishing marginal returns occur?
When marginal product of an additional worker is less than the marginal product of the
previous worker. It occurs because more and more people are working in the same space.
30. How does MP and AP relate? 1) MP intersects AP at maximum 2) MP>AP AP is increasing 3)
MP<AP AP is decreasing
31. Total fixed cost includes: 1) Cost of renting capital (plant costs)
2) Normal profit
32. What happens to the vertical distance between AVC and ATC as output increases? It shrinks
because the AFC declines with increasing output.
33. How does MC and AC curves relate? 1) MC intersects both AVC and ATC at minimum
2) When MC<AVC/ATC AVC/ATC is decreasing
3) When MC>AVC/ATC AVC/ATC is increasing
34. Why is the ATC U-shaped? 1) Spreading total fixed cost over a larger output
2) Eventual diminishing returns
35. What is the relationship between AP, MP and AVC and MC? 1) AP is max when AVC is min |
MP is max when AP is min 2) As MP increases MC decreases | AP increases, AVC decreases
3) As MP decreases MC increases | AP decreases, AVC increases
36. What are the two factors that position a firm's short run costs? 1) Technology (at small
outputs, ATC might increase, but at large outputs ATC decreases) 2) Prices of factors of
production
37. The production function is the relationship between: Maximum output attainable and the
quantities of both labour and capital.
38. What are Q, L, K, W and R Q = Quantity, L = Labour, K = Capital, W = Wages, R = Capital Cost
(Rent)
39. What are economies of scale and when do they occur? Features of a firm's technology that
make ATC fall as output increases. Slope downward on LRAC curve.
40. What are diseconomies of scale and when do they occur? Features of a firm's technology
that makes average total cost rise as output increases. Slope upward on LRAC curve.
41. What is a constant return to scale? Average total cost is constant as output increases.
(Replicating a plant rather than adding more capital)
42. What is minimum efficient scale? Smallest output at which long-run average cost reaches its
lowest level.
43. How does minimum efficient scale determine how many firms in market? If MES is small,
room for many firms; if large room for few firms.