3.4.4 - Costs of Production

Question 1

What does production entail?

Answer 1

Converting inputs to outputs without a consideration for money costs of using inputs like capital and labour.

Question 2

What is the short-run?

Answer 2

When at least one factors of production is fixed.

Question 3

What is the long-run?

Answer 3

When none of the factors of production can all be changed.

Question 4

What are short run costs made of?

Answer 4

Fixed costs and costs incurred when hiring the services of the variable factors of production.

Question 5

What are long run costs made of?

Answer 5

Only variable costs.

In the long term, there are no fixed costs as all factors of production are variable.

Question 6

What is fixed cost?

Answer 6

The cost of production, which in the short run, does not change with output.

Question 7

What is variable cost?

Answer 7

The cost of production which changed with the amount that is produced, even in the short run.

Question 8

What are generally assumed to be fixed costs in the short term?

Answer 8

Capital, Land (possibly enterprise)

Question 9

What does capital involve in terms of fixed costs?

Answer 9

The cost of maintaining a firm’s buildings as well as the initial cost of acquiring buildings such as factory space and offices.

Question 10

What are generally considered variable costs of production in the short term?

Answer 10

Labour and the cost of raw materials.

Question 11

What is total cost?

Answer 11

The cost incurred when producing a particular size of output.

Question 12

What is average variable cost?

Answer 12

The total variable cost divided by size of output.

Question 13

What is marginal cost?

Answer 13

The addition to total cost resulting from producing one additional unit of output.

Question 14

What happens in terms of costs when a firm increases its output?

Answer 14

The total cost of production increases.

Question 15

How does one derive the Marginal Cost (MC) curve from the Average Variable Cost (AVC) curve and the marginal and average returns curves?

Answer 15

Take the difference of two total costs, then divide by the total change in outputs between those two.

Question 16

What are average fixed costs?

Answer 16

Costs of employing the factors of production / Size of output.

Question 17

What are the fixed costs of production also known as?

Answer 17

Overheads.

Question 18

What are the overheads that most businesses pay in the short run?

Answer 18

Rent on land, maintenance on buildings etc.

Question 19

How do the overheads of a company change as they produce more cars?

Answer 19

As more cars are produced, the actual overheads do not change as they are fixed, however, the average fixed costs per car falls per each car is made.

If the overhead is 1 million, and the company produces one car, the average fixed cost per car is 1 million. If they produce 2, the average fixed cost per car is 500,000. If they produce 3, the average fixed cost per car is 333,333 etc.

Question 20

Can average costs of production ever equal 0?

Answer 20

No. Although they can get very close.

Question 21

What is average total cost?

Answer 21

The total cost of producing a particular level of output, divided by the size of output: ATC = AFC + AVC.

Question 22

How can you find the average total cost?

Answer 22

Add the AFC and AVC curves at any point of output.

Question 23

What is interesting about the Average Total Cost Graph in the short run?

Answer 23

The average costs of production fall initially, but at higher levels of output average costs usually rise.

Question 24

Why do ATC curves decrease and then increase?

Answer 24

Employing more workers up to a certain point increases the business output more than employing new workers increases the businesses costs.

Question 25

Where does the MC curve go in terms of the AFC and AVC curves?

Answer 25

The MC curve cuts from below both the AVC and AFC curves at the lowest points of each of the curves.

Question 26

What are factor prices?

Answer 26

The prices a firm pays for hiring the different factors of production.

Question 27

What is the factor reward of capital?

Answer 27

Interest.

Question 28

What are the factor rewards of labour?

Answer 28

Wages and salaries.

Question 29

What is capital productivity?

Answer 29

The output per unit of capital employed.

Question 30

What do economists have to assume about firms?

Answer 30

They have one business objective.

Question 31

What is a firms business objective?

Answer 31

To maximise profits.

Question 32

How do firms maximise profits?

Answer 32

Employing the optimal factor combination of minimising costs and maximising outputs.

Question 33

How do factor prices and productivity factor into profit maximisation?

Answer 33

For example, if the government passes a law increasing the national minimum wage to £15ph, capital employment becomes more attractive compared to labour employment.

However, if labour in the UK becomes massively inefficient, but their wage costs are also low, firms may choose to increase their employment of capital provided the high capital costs are offset by the higher levels of capital efficiency.

Capital-intensive production is often paired with reduced labour, however, the average wages of the reduced workers are higher as they are often more skilled to be able to operate the machinery.

If consumers demand more of a product with capital-intensive production, firms will begin to employ more capital and more labour. This has provided evidence that, contrary to popular belief, greater usage of robotised machinery can lead to higher wage and employment levels in the UK.