4- Costs Flashcards
Total cost definition
The sum of all costs that a firm faces.
Fixed costs + variable costs
Average cost definition
Total cost / quantity produced
Fixed cost
A cost which does not vary with the volume of production.
Examples of fixed costs
- Rent payments
- Insurance
- Interest payments
- Certain salaries
Variable cost
A business’ costs associated with the number of goods and services it produces.
Examples of variable costs
- Wages
- Costs of raw materials
- Inputs to production
- Commission
Marginal cost definition
The cost added by producing one additional unit of a product or service.
Marginal cost equation
Change in cost/ change in revenue
The law of diminishing returns
As more of a variable factor is added to a fixed factor, the increase in output (or marginal product) eventually falls. Only operates in the short run.
Marginal product definition
The extra output when one more factor of output is added.
Fixed factor definition
The factor of production, which cannot be changed in the short run.
Economies of scale
Occur when the average costs per unit of output decrease with the increase in the scale of the output being produced by a firm in the long run. Occurs only in the long run.
Types of economies of scale?
- Managerial economies
- Financial economies
- Commercial economies
- Technical economies
- Marketing economies
What are managerial economies of scale?
When larger firms can appoint better managers which usually means better management, higher profits and longer term sustainability.
What are financial economies of scale?`
Large firms have more access to credit and at lower prices. Large firms can also issue shares on the stock market and do deals with lenders to borrow at cheaper rates. This is because large firms have of collateral so are seen as a safer bet ( they have more assets to pay off debt if their payments dry up).
What are commercial economies of scale?
Large firms can bulk-buy from their suppliers because they buy a large amount at a steady rate they are likely to get better deals.
What are technical economies of scale?
Larger scale production can increase can produce more e.g. a larger lorry can carry more.
What are marketing economies of scale?
As a firm grows bigger, the cost of advertising is spread out over a large number of potential customers.
Diseconomies of scale
Occur when the average unit costs of production increase beyond a certain level of output.
What is the minimum efficient scale?
A concept which applies to firms with very high fixed costs, which find that costs fall very rapidly as output begins, as costs are being spread out. The point where the average costs are at a minimum.
Reasons for diseconomies of scale?
- Unwieldiness- Large firms can become difficult to manage in different countries with different cultures, decisions may take longer to implement and the person making the decision may not have the knowledge of the outcome.
- Slowness- takes large firms a long time to respond in many cases
- X-inefficiency- lack of competition may mean costs are allowed to rise.
- Communication- workers may face delays with tasks with lots of meetings, emails.
- Lack of engagement- in large firms the management may become very distant from workers. Workers may become less loyal to management. Could lead to more days sick, more inefficiency and no concern on how it impacts profit.
External economies of scale?
External economies of scale are business-enhancing factors that occur outside a company but within the same industry.
E.g. faster transport, connection, all lower LRAC curve
External diseconomies of scale?
External diseconomies of scale occur when an industry growing in size causes negative externalities – and rising long-run average costs.
E.g. high cost of rent when lots of financial firms want to be based in the city.
High traffic congestion
What is the difference between internal and external economies of scale?
Internal economies of scale is when firms get bigger, and external is when the industry gets bigger.
