3.3.2 - Costs Flashcards
Define short run
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
Why is one FOP fixed in the short run
- can vary the amount of labour e.g overtime, hire workers
- ## capital has less flexibility so it is fixed in short run
Define Long run
A period of time when all factors of production are variable and a business can change the scale of production.
Define fixed costs
Business expenses that do not vary directly with the level of output in the short run.
Define sunk costs
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)
Define variable costs
Variable costs are business costs that vary directly with output since more variable inputs are required to increase output. Also known as prime costs.
Define total costs
variable costs + fixed costs
all the costs involved in producing a particular level of output
Define total costs
variable costs + fixed costs
What is a common assumption regarding costs
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
What happens to afc as output increases
average fixed costs = fixed costs/output
- afc falls as fixed costs are spread acorss a greater output
what is average variable cost is
avc = variable cost/output
Define marginal cost
The change in total costs from increasing output by one extra unit.
e.g gradient of total cost curve
What is the effect of MC on AC
- 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
Where does MC meet average costs
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
abbreviation of marginal cost
change in TC/change in quantity
What happens to diff between atc and avc as output rises
- 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
check CGP page 41 on marginal costs
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explain law of diminishing returns
- 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
define diminishing marginal productivity
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!!!
simplify diminishing marginal productivity
- 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
Why is ATC curve u shaped
- 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
why is marginal cost u shaped
- due to law of diminishing marginal productivity
- will initially fals as machines used more efficiently but rises as production also rises
describe the shape of marginal cost curve
- always cuts AC line at the lowest point on the ac curve
What is the relationship between short run and long run cost curves
- 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
what does LRAC curve represent
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
Why do shifts and movements in LRAC occur
- 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
