3.3.2 - Costs

Question 1

Define short run

Answer 1

A time period where at least one factor of production is in fixed supply. We normally assume that the quantity of plant and machinery is fixed and that production can be altered through changing labour, raw materials and energy

Question 2

Why is one FOP fixed in the short run

Answer 2

• can vary the amount of labour e.g overtime, hire workers
• ## capital has less flexibility so it is fixed in short run

Question 3

Define Long run

Answer 3

A period of time when all factors of production are variable and a business can change the scale of production.

Question 4

Define fixed costs

Answer 4

Business expenses that do not vary directly with the level of output in the short run.

Question 5

Define sunk costs

Answer 5

Sunk costs cannot be recovered if a business decides to leave an industry. The existence of sunk costs makes a market less contestable (sunk costs paid even if a firm isn’t producing anything)

Question 6

Define variable costs

Answer 6

Variable costs are business costs that vary directly with output since more variable inputs are required to increase output. Also known as prime costs.

Question 7

Define total costs

Answer 7

variable costs + fixed costs
all the costs involved in producing a particular level of output

Question 7

Define total costs

Answer 7

variable costs + fixed costs

Question 8

What is a common assumption regarding costs

Answer 8

In the short run, at very low levels of output, total costs will rise more slowly than output, but than as diminishing returns set in (ie less additional output per unit of labour with each increase), total costs will accelerate

Question 9

What happens to afc as output increases

Answer 9

average fixed costs = fixed costs/output
- afc falls as fixed costs are spread acorss a greater output

Question 10

what is average variable cost is

Answer 10

avc = variable cost/output

Question 11

Define marginal cost

Answer 11

The change in total costs from increasing output by one extra unit.
e.g gradient of total cost curve

Question 12

What is the effect of MC on AC

Answer 12

• If the marginal cost is greater than average cost, the average must be rising
  -If average is not rising or falling, marginal cost is equal to average cost and the average has stopped fallung and has yet to start rising
• ie take average of a group of people’s heights - if a new person is added and is taller/shorter than the average then the average will rise/fall

Question 13

Where does MC meet average costs

Answer 13

MC meets the average cost curve at the lowest average cost, i.e. average cost will be lowest when MC=AC - this is the point of productive efficiency

Question 14

abbreviation of marginal cost

Answer 14

change in TC/change in quantity

Question 15

What happens to diff between atc and avc as output rises

Answer 15

• gets smaller
• as output rises, AC in nearer value to AVC bc AFc is always falling as output rises and AVC starts to rise bc of law of diminsihing returns

Question 16

check CGP page 41 on marginal costs

Answer 16

aa

Question 17

explain law of diminishing returns

Answer 17

• if firm increases amount of inputs of the variable factor (labour) whilst holding constant the input of the other factor (capital)
• gradually, less additional output per unit of labour is derived for each further increase in variable factor
• relies on assumption capital is fixed so it is a SR concept

Question 18

define diminishing marginal productivity

Answer 18

As more of a variable factor (e.g. labour) is added to a fixed factor (e.g. capital), a firm will reach a point where it has a disproportionate quantity of labour to capital and so the marginal product of labour will fall, thus raising
marginal costs.

AKA LAW OF DIMINISHING RETURNS!!!

Question 19

simplify diminishing marginal productivity

Answer 19

• 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 eun so marginal cost of production will rise

Question 20

Why is ATC curve u shaped

Answer 20

• due to law of diminishing marginal productivity
• costs fall as machine is used more efficiently as first but as production expands, efficiency falls as machines are over used

Question 21

why is marginal cost u shaped

Answer 21

• due to law of diminishing marginal productivity
• will initially fals as machines used more efficiently but rises as production also rises

Question 22

describe the shape of marginal cost curve

Answer 22

• always cuts AC line at the lowest point on the ac curve

Question 23

What is the relationship between short run and long run cost curves

Answer 23

• SRAC curve U shaped due to law of DR
• LRAC curve u shaped due to economies and diseconomies of scale
• check pmt booklet envelope para

Question 24

what does LRAC curve represent

Answer 24

the minimum possible average cost at each level of output is shown by a LRAC curve
- points below LRAC are unattainable and producing above LRAC is inefficient

Question 25

Why do shifts and movements in LRAC occur

Answer 25

• movements: chnage in output which changes the average cost of production due to internal economies/diseconomies of scale
• shifts: external economies/diseconomies of scale/ changes in taxes or new technology (down shift which affects the cost of production for a given level of output