A firm’s costs depend on the inputs it needs to produce output and the prices it pays for those inputs. This lesson connects a firm’s production function to its cost function.
A firm uses factors of production—such as labor, land, physical capital, financial capital, and entrepreneurship—to produce goods and services. The payment for using each factor is a factor payment. From the firm’s perspective, factor payments are costs; to the owners of the factors, they are income.
All flashcards
What is a factor payment?
A payment made for the use of a factor of production. It is a cost to the firm and income to the factor’s owner.
How can a production function help determine cost?
Read backward, it shows the amount of each input needed for a target output. Combining those input amounts with their prices gives production costs.
What is a cost function?
A mathematical expression, equation, or table showing the cost of producing different levels of output.
Name four examples of factor payments.
Examples include raw-material prices, rent for land or buildings, wages and salaries for labor, and interest or dividends for financial capital.
Why can profit be viewed as a payment to entrepreneurship?
Profit is the residual remaining after other costs are paid and is the return entrepreneurs receive for organizing a business and bearing risk.
Quiz questions
A firm pays rent on a leased factory, and the rent does not change with output during the short run. How is this cost classified?Answer: Fixed cost
At positive output, why is average total cost greater than average variable cost?Answer: Average total cost includes average fixed cost.
Where does marginal cost intersect average total cost?Answer: At the minimum of average total cost.
How should a firm treat an unrecoverable expense from the past when making a current production decision?Answer: It is a sunk cost and generally does not determine the current choice.
If producing one more unit brings in marginal revenue greater than marginal cost, what happens to profit, assuming other conditions are unchanged?Answer: The additional unit increases profit.
Based on Principles of Economics 3e by Steven A. Greenlaw, David Shapiro, Daniel MacDonald (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.