4.4 Costs Of Production

Question 1

In the short run….

Answer 1

• the scale of production is fixed
• there is at least one fixed cost

Question 2

In the long run…

Answer 2

• all factor inputs can change.
• all costs are variable.
• For example, the production process might move to a new factory or premises, which is
  not possible in the short run.

Question 3

The measure of the short run…

Answer 3

• varies with industry.
• there is no standard.

-,For example, the short run for the pharmaceutical industry is likely to be significantly
longer than the short run for the retail industry.

Question 4

What are fixed costs?

Answer 4

• are costs which do NOT vary with output.
• They are indirect.
• For example, rents, advertising and capital goods are fixed costs.

Question 5

What are variable costs?

Answer 5

• change with output.
• they are direct costs.
• For example, the cost of raw materials increase as output increases.

Question 6

What are total costs?

Answer 6

• is the cost to produce a given level of output.

Question 7

What is the calculation for total costs?

Answer 7

• total costs =
  total variable costs + total fixed costs

Question 8

What are average costs?

Answer 8

• is the cost per unit

Question 9

What is the calculation for average costs?

Answer 9

• Average costs =
  total costs / quantity produced

Question 10

What is the marginal costs of production?

Answer 10

• is the cost of producing one extra unit of output.

Question 11

What does the law of diminishing returns state?

Answer 11

• after a point, marginal costs rise as output increases.

Question 12

Draw a short run average costs curve
Explain the shape of this curve

Answer 12

• The short run average total cost curve is U shaped

Question 13

Why is the SRAC curve U shaped?

Answer 13

• because of the law of diminishing returns.
• This is because the factors of production are fixed.
• At one point, employing more resources will be less productive
• this means the marginal output decreases per extra factor of production.
• Marginal costs start to increase.

Question 14

Draw a long run average cost curve
Explain this curve (economies/
diseconomies of scale)

Answer 14

• average costs fall, since firms can take advantage of economies of scale-means 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 15

How do factor prices and productivity affect a firms costs of production and their choice of factor inputs?

Answer 15

• If factor inputs become more productive, firms can produce more output with a smaller input.
  -This results in lower unit costs of production.
• As the average cost per unit of one factor input rises, such as labour, firms are likely
  to switch to cheaper (and generally more productive) factor inputs, such as capital.