3.3.2 Costs Flashcards
Economic cost of production:
The opportunity cost of production. The value that could have been generated had the resources been employed in their next best use.
Total costs
Total cost - the cost of producing a given level of output.
- Fixed cost + Variable cost.
Total fixed cost - costs that do not change with output and remain constant.
Total variable cost - costs that change directly with output.
Average costs:
Average cost is the average cost of production per unit.
Average total cost - total cost / output
Average fixed cost - total fixed cost / output
Average variable cost - total variable cost / output
Marginal Cost
> Marginal cost - The cost of producing one extra unit of output.
Calculated by:
- Change in total cost / change in output.
When a firms variable costs increase, both the marginal cost curve and average cost curve shifts upwards. When fixed costs increase, only the average cost curve shifts upwards.
Short run cost curves and the assumption of diminishing marginal productivity (part 1):
The short run is the length of time when at least one factor of production is fixed and can’t be changed.
The long run is when all factors of production become variable.
In the very long run the state of technology can change.
Part 2 - Diminishing marginal productivity
> Diminishing marginal productivity means that if a variable factor is increased when another factor is fixed, there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.
Marginal output will decrease as more inputs are added in the short run, meaning the MC curve will rise.
Part 3 - curves
(Diagram sheet 4)
> Average Fixed Cost curve - starts high because fixed costs are divided by a small output. A output increases, AFC falls as its being divided by a larger number.
> Average Total Cost curve - U-shaped due to the law of diminishing marginal productivity. Costs initially fall as input factors are used more efficiently but as production expands efficiency falls as the inputs are overused.
> Average Variable Cost curve - also U-shaped but gets closer to ATC curve as output increases because AFC gets smaller.
> Marginal Cost curve - also U-shaped due to law of diminishing marginal productivity. Will initially fall as factors of production are used more efficiently but will rise as production rises.
Part 4 - curves continued
The marginal cost curve will always cross the AC curve at its lowest point. If MC is below AC then AC would continue to fall since producing one more costs less than the average.
But if MC is above AC, AC will rise.
SRAC and LRAC curves:
(Diagram sheet 4)
> Short run average cost curves are U-shaped because of the law of diminishing returns.
> Long run average cost curves are U-shaped because of economies and diseconomies of scale.
Part 2
> The LRAC is either equal to or below the relevant SRAC.
A firm may be set up to produce a certain amount each day and have enough machinery to effectively do so. If they become popular and need to produce more than this amount, in the short run this will cause a rise in STAC due to the law of diminishing returns, as some factors of production are fixed.
In the long run all factors become variable and the SRAC curve can be shifted. The new curve will be lower because the firm is able to enjoy economies of scale.
This will continue until the firm begins to experience constant returns to sale and eventually diseconomies of scale.
Part 3
> Up to Q1 the firm experiences economies of scale and sees falling LRAC.
From Q1-Q2 the firm experiences constant returns to scale where LRAC are constant.
From above Q2 the firm experiences diseconomies of scale and their LRAC rises.
Shifts and movement of the LRAC curve
> The LRAC curve is a boundary representing the minimum level of average costs attainable at any given level of output. Points below it are unattainable and producing above it is inefficient.
Movement along it is due to a change in output, which changes the average cost of production due to economies or diseconomies of scale.
A shift can occur due to external economies/diseconomies of scale, taxes or technology, which effects the cost of production for a given level of output.
