3.2 costs and Flashcards
what is the difference between the short run and the long run?
in the short run:
there is fixed factors of production which cannot be varied and variable factors of production
the firm sticks with its scale of production
the law of diminishing returns applies.
in the long run:
all factors of production are variable
all costs are variable
the firm sees economies and diseconomies of scale
what is a fixed cost?
a cost that does not vary as the level of output changes
they have to be paid no matter what and are indirect.
e.g rent
what is a variable cost?
costs that relate directly to the production or sale of a product.
a change in output will change vc
e.g raw materials, wages
what is the formula for total cost?
total cost = fixed + variable costs
tc= tfc + tvc
what is average cost?
cost per unit of output
average cost = total cost/output
what is marginal cost?
the change in total cost as a result of producing one extra unit
mc = change in total costs/change in output
this only relates to variable costs as fixed costs stay the same.
what happens to AFC as output increases?
falls continuously
what does marginal cost and average total cost look like on a diagram?
MC curve is j-shaped
AC curve is u-shaped
MC cute AC at MCs lowest point.
what is the law of diminishing returns?
as a firm increases its inputs of one factor of production (variable), whilst holding factor inputs (fixed), eventually firms get less additional output per unit of input.
at first, increasing variable inputs increases output however, adding more after a certain point will mean the return falls and costs are higher.
why is the MC curve j-shaped?
due to diminishing marginal returns
why is the AC curve u-shaped?
due to marginal cost
what is the relationship between MC and AC?
if mc is falling, AC must be falling as each extra unit lowers average costs but as MC rises average costs must rise.
what is the marginal physical product?
the additional quantity of output produced by an additional unit of labour.
what is total product?
total output
what is average product?
output pet worker or output per unit of capital
what is the marginal product?
the change in output from additional workers or machinery
what do returns to scale mean?
how a business responds to a change in inputs.
change in inputs < change in output - increasing
change inputs = change in output - constant
change in inputs > change in output - decreasing
what does each point of the LRAC curve mean?
when it is falling- there is increasing returns to scale (econs of scale)
when it is flat - at the first point (mes), then is constant returns to scale
when it is then increasing- there is decreasing returns to scale (diseconomies)
what is the minimum efficient scale (MES)?
the minimum point of the LRAC curve ; the output level where cost per unit is lowest.
explain LRAC as an envelope curve
at first, we are on SRAC1, with a small factory. as output rises, SR costs fall as spare capacity in our fixed FOP is used up. Beyond A, unit costs rise as output rises (perhaps due to labour overcrowding). so more capital is added - all FOPs are now variable so now in long run. mover along LRAC to SRAC 2
what are economies of scale?
when an increase in output leads to lower long run average costs.
as output increases, costs fall
what is an internal economy of scale?
economies of scale that arise from the expansion of a firm
what are the types of internal economies of scale?
technical - scaling up production e.g specialisation, machinery
marketing - spread marketing budgets over more units
managerial- specialist managers and HR improves communication and productivity
financial - easier access to credit and negotiate interest
purchasing-bulk buying
what is an external economy of scale?
economies of scale due to the expansion of the industry
what are the types of external economy of scale?
concentration - close to suppliers and other firms
tech and skills - pool of skilled labour reduces training and recruitment costs e.g silicone valley, cambridge
what does an internal and external economy of scale look like on a diagram?
internal - movement along LRAC
external - shift down of LRAC
what is a diseconomy of scale?
when an increase in the scale of production leads to higher long run average costs, resulting from a business expanding beyond its optimum size and loosing productive efficiency
what are the types of diseconomy of scale?
communication- layers of hierarchy and large teams, principal-agent,alienated workers
motivation - hard to motivate workers
internal politics
information overload
what are the effects of diseconomies of scale?
- may charge higher prices in order to cover costs
-loss of competitiveness leading to a lower market share and share price
what are the evaluating arguments for economies and diseconomies of scale?
- incentive to expand
-more important to firms that face large fixed costs - econs of scale are limited
-difficult to know optimum level
-effects ability of firms to compete (market dominated)
