4.1.4.4 Costs of production

Question 1

fixed costs

Answer 1

Costs that don’t vary with output in the short run- they have to be paid whether or not anything is produced e.g. rent

Question 2

variable costs

Answer 2

costs that do vary with output- they increase as output increases e.g. material costs

Question 3

marginal costs

Answer 3

is the extra cost incurred as a result of producing the final unit of output (i.e. the change in the total cost from producing one more)

Question 4

What happens to average fixed cost as more units of output are produced?

Answer 4

Fixed costs stay the same because these costs have to be paid whether or not anything is produced. However the average fixed cost falls becuase you are dividing by more units of output

Question 5

average cost (cost per unit)

Answer 5

the total cost divided by the quantity produced

Question 6

Total Cost (TC)

Answer 6

The whole cost of output (total fixed costs + total variable costs)

Question 7

Average Fixed Cost (AFC)

Answer 7

total fixed costs divided by quantity of output

Question 8

Average Variable Cost (AVC)

Answer 8

total variable costs divided by quantity of output

Question 9

Average Total Cost (ATC)

Answer 9

total costs (fixed costs + variable costs) divided by quantity of output

Question 10

Total Variable Cost (TVC)

Answer 10

the total of all costs that vary with output in the short run

Question 11

Total Fixed Cost (TFC)

Answer 11

the sum of the firm’s fixed costs

Question 12

Examples of fixed costs

Answer 12

• rent
• insurance on buildings
• interest payments on borrowed capital
• fire insurance

Question 13

Examples of variable costs

Answer 13

direct raw materials and direct labour costs

Question 14

What shape is the total fixed cost curve in the short run and why?

Answer 14

A horizontal line because they don’t change as the level of production changes

Question 15

Short-Run Average Total Cost Curve

Answer 15

• A ‘U’ shaped due to diminishing returns.
• This because the factors of production are fixed.
• At one point, employing more resources will be less productive, which means the marginal output decreases per extra factor of production and then marginal costs start to increase.

Question 16

Long-Run Average Cost Curve

Answer 16

• Shows the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed
• Initially, average costs fall, since firms can take advantage of economies of scale. This means that average costs are falling as output increases.
  After the optimum level of output, where average costs are at their lowest, average costs rise due to diseconomies of scale.

Question 17

How do you calculate MC?

Answer 17

MC = ∆TC ÷ ∆Q

Question 18

How do you calculate total variable costs (TVC)?

Answer 18

TVC = Variable cost per unit × Q

Question 19

Describe the TVC curve.

Answer 19

Slopes up at an accelerating rate, reflecting the law of diminishing marginal returns.

Question 20

How do you calculate total costs (TC)?

Answer 20

TC = TFC + TVC
or
TC = AC × Q

Question 21

What does the TC curve reflect?

Answer 21

The position of the TC curve reflects the amount of fixed costs.
The gradient reflects variable costs.

Question 22

whats happens to average variable costs, as output increases

Answer 22

initially it falls. However, as output reaches higher levels, more units of factors of production (usually labour) begin to overcrowd fixed factors of production, leading to bottlenecks and disruption in productivity, thus it rises

Question 23

where does marginal cost curve always intersect with the average total cost curve

Answer 23

at the minimum of the average total cost curve

Question 24

Formula for TVC

Answer 24

Total output quantity x variable cost of each output unit = total variable cost

Question 25

What happens if factor inputs become more productive?

Answer 25

firms can produce more output with a smaller input. This results in lower unit costs of production.

Question 26

If the average cost per unit rises such as labour what are firms most likely to do ?

Answer 26

firms are likely to switch to cheaper (and generally more productive) factor inputs, such as capital.