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M i c > 7 - Costs > Flashcards

7 - Costs Flashcards

1
Q

What do business people and economists need to understand to determine the most cost-efficient way to produce?

A

The relationship between the costs of inputs and production.

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2
Q

What is an additional reason economists, in particular, want to understand the relationship between output and costs?

A

Because it plays an important role in determining the nature of a market - how many firms are in the market and how high price is relative to cost.

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3
Q

How must a manager think to run a firm profitably?

A

Though he may direct his accountants differently, he must think like an economist and consider all relevant costs.

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4
Q

What is the economic cost or opportunity cost of a resource?

A

The value of the best alternative use of that resource.

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5
Q

Why do MBA applications rise in bad economic times when outside opportunities decline??

A

People thinking of going back to school face a reduced opportunity cost of entering an MBA program if they think they may be laid off or not promoted during an economic downturn.

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6
Q

What kind of good is capital?

A

A durable good.

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7
Q

What is a durable good?

A

A product that is usable for a long period, typically for many years.

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8
Q

What’s the first problem to arise in measuring the cost of capital?

A

How to allocate the initial purchase cost over time.

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9
Q

What’s the second problem to arise in measuring the cost of capital?

A

What to do if the value of the capital changes over time.

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10
Q

How can we avoid the two problems which arise in measuring the cost of capital?

A

By renting capital instead of purchasing it, a firm calculates the cost of this capital the same way that it calculates the cost of nondurable inputs such as labour services or materials.

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11
Q

What is the true opportunity cost of a truck that a firm owns?

A

The amount that the firm could earn if it rented the truck to others.

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12
Q

Regardless of whether the firm rents or buys a truck, how does the manager view the opportunity cost of this capital good?

A

As the rental rate for a given period.

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13
Q

Why would some of a firm’s opportunity costs decline?

A

Because the values of trucks, machines and other equipment decline over time, their rental rates fall.

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14
Q

Why would some of a firm’s opportunity costs increase?

A

Because the value of some land, buildings, and other forms of capital may rise over time, their rental rates rise.

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15
Q

What is a sunk cost?

A

A past expenditure that cannot be recovered.

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16
Q

Why are sunk costs not relevant to a manager when deciding how much to produce now?

A

Because a sunk cost isn’t an opportunity cost.

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17
Q

If a firm buys a forklift for $25’000 and can resell it for the same price, what are it’s sunk costs and opportunity costs and should the firm include it in their current cost calculations?

A

Yes
Sunk cost: $0
Opportunity cost: $25’000

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18
Q

If a firm buys a specialized piece of equipment for $25’000 and cannot resell it, what are it’s sunk costs and opportunity costs, and should the firm include it in their current cost calculations?

A

No
Sunk cost: $25’000
Opportunity cost: $0 (because it has no alternative use and cannot be resold)

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19
Q

If a firm buys a specialized piece of equipment for $25’000 and can resell it for $10’000, what are it’s sunk costs and opportunity costs and should the firm include it in their current cost calculations?

A

Yes
Sunk cost: $15’000
Opportunity cost: $10’000

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20
Q

What does a firm need to know to make profit-maximizing decisions?

A

How its cost varies with output. A firm’s cost rises as it increases its output.

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21
Q

What is the difference between short-run and long-run cost analyses?

A
  • The short-run: some inputs (labor) can be varied, while other inputs (capital) are fixed.
  • Long-run: All inputs can be varied.
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22
Q

To produce a given level of output in the short-run, a firm incurs costs for which two inputs?

A

Fixed and variable inputs.

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23
Q

What is a fixed cost (F)?

A

A cost that doesn’t vary with the level of output. Fixed costs cannot be avoided by reducing output and must be incurred as long as the firm stays in business.

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24
Q

Are fixed costs sunk costs?

A

Often but not always.

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25
Q

What is a variable cost (VC)?

A

The production expense that changes with the quantity of output produced. The variable cost is the cost of the variable inputs - the inputs the firm can adjust to alter its output level.

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26
Q

What is a firm’s total cost (or just “cost”)?

A

C = F + VC

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27
Q

Why does total cost vary with the level of output?

A

Because variable costs change with the level of output.

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28
Q

To decided how much to produce, which measures does a firm use?

A

Marginal costs (MC) and Average costs (AC).

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29
Q

What is marginal cost (MC)?

A

The amount by which a firm’s cost changes if it produced one more unit of output.

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30
Q

What is MC mathematically?

A

MC = dC(q)/dq

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31
Q

How else can we define MC mathematically?

A

MC = dVC(q)/dq where VC(q) is the firm’s variable cost function

32
Q

When does a firm use MC?

A

To decide whether changing its output level pays off.

33
Q

What are the three average cost (AC) measures?

A
  • Average fixed costs (AFC)
  • Average variable costs (AVC)
  • Average cost (AC)
34
Q

What is AFC?

A

AFC = F/q

35
Q

What happens to AFC as output rises and why?

A

AFC falls as output rises because the fixed cost is spread over more units.
dAFC/dq = -F/q² < 0

36
Q

When does the AFC curve approach 0?

A

It approaches 0 as the output grows large.

37
Q

What is AVC?

A

AVC = VC/q

38
Q

What happens to AVC as output rises and why?

A

Because the variable cost increases with output, the average variable cost may either increase or decrease as output rises.

39
Q

When does a firm use AVC?

A

To determine whether to shut down operations when demand is low.

40
Q

What is AC?

A

AC = C/q = (VC+F)/q = AVC + AFC

41
Q

When does a firm use AC?

A

To determine if the firm is making a profit.

42
Q

Given a short-run cost function, how do we find a firm’s short-run fixed cost and variable cost function?

A

Identify the fixed cost as the part of the short-run cost function that doesn’t vary with output, q, and the remaining part of the cost function as the variable cost function.

43
Q

A manufacturing plant has a short-run cost function of

C(q) = 100q - 4q² + 0.2q³ + 450. What is the firm’s short-run fixed cost and variable cost function?

A 
F = 450
VC(q) = 100q - 4q² + 0.2q³
44
Q

Given a short-run cost function, how do we find a firm’s short-run MC, AFC, AVC, and AC?

A
  • Determine the MC by differentiating the short-run cost function (or the VC function) with respect to output.
  • Calculate the three average cost functions using their definitions.
45
Q

Describe the F curve.

A

The F curve, which does not vary with output, is a horizontal line at a given level.

46
Q

Describe the VC curve.

A

The VC curve is 0 when q is 0 and rises as q increases.

47
Q

Describe the C curve.

A

The C curve, which is the vertical sum of the VC curve and the F line, is F higher than VC at every q level. C and VC are parallel.

48
Q

Describe the AFC curve.

A

The AFC curve falls as q increases. It approaches 0 as q gets larger because F is spread over many units of q.

49
Q

Describe the AC curve.

A

The AC curve is the vertical sum of the AFC and AVC curves. The AC (or AVC) rises where it lies below the MC curve and falls where it lies above the MC curve

50
Q

Describe the MC curve.

A

The MC curve cuts the U-shaped AC and the AVC curves at their minimums.

51
Q

How can you determine the output level q where the average cost curve, AC(q), reaches its minimum?

A

Set the derivative of the average cost
, AC(q), with respect to q equal to 0.
This condition holds at the output q where MC = AC.
The second order condition requires that the AC curves be falling to the left of this quantity and rising to the right.

52
Q

What determines the shape of a firm’s cost curves?

A

The production function.

53
Q

If a firm produces output using capital and labour and its capital is fixed in the short run, what is the firms variable costs?

A

It’s costs of labour.

54
Q

What is a firm’s labour cost?

A

The wage per hour, w, times the number of hours of labour, L.

55
Q

In the short run, what is a firm’s VC?

A

VC = wL

56
Q

Rewrite the production function in the short run.

A 
q = f(L,K) (k held constant)
q = f(L)
q = g(L)
57
Q

Rewrite the cost function in the short run.

A

Because in the short run VC = wL

C(q) = V(q) + F = w(g^-1(q)) + F

58
Q

What does it mean if the production function exhibits diminishing marginal returns?

A

That the VC rises more than in proportion as output increases.

59
Q

What is the extra labour required to produce one more unit of output?

A

dL/dq = 1/MPL

60
Q

Redefine MC in the short-run.

A

MC = dV(q)/dq = w(dL/dq) = w/MPL

61
Q

What does MC = w/MPL show?

A

That, with a constant wage, the MC moves in opposite direction to that of the MPL.

62
Q

Describe how the MC moves in opposite direction to that of the MPL.

A

At low levels of labour, the MPL rises with additional workers who may help the original workers to collectively make better use of the firm’s equipment.
Eventually, however, as the number of workers increases, workers must share the fixed amount of equipment and may get in each other’s way.

63
Q

Why does the MC slope upward in the short run?

A

The MC curve slopes upward due to diminishing marginal returns to labour. As a result, the MC curve first falls and then rises.

64
Q

What is AVC for a firm that has labour as its only input?

A

AVC = VC/q = wL/q

65
Q

What is AVC for a firm that has labour as its only input in terms of APL and why?

A

Because APL is q/L

AVC = w/APL

66
Q

What does AVC = w/APL show?

A

That, with a constant wage, the AVC moves in opposite direction to that of the APL.

67
Q

Why does the AVC curve tend to fall and then rise in the short run?

A

Because the APL tends to rise and then fall. and APL and AVC move in opposite directions.

68
Q

Describe why the AC curve is U-shaped.

A

AC = AVC + AFC
If the AVC is U-shaped, adding strictly falling AFC makes the AC fall more steeply than the AVC at low q. At high q, the AC and AVC differ by ever-smaller amounts, as the AFC, F/q, approaches 0.
Thus, the AC is also U-shaped.

69
Q

What is required to construct all the cost measures?

A

The production and the prices of the inputs (w,r)

70
Q

What is the effect of taxes on cost curves?

A

Taxes applied to a firm shift some or all of the marginal and average cost curves.

71
Q

How does a specific tax affect a firm’s costs?

A

A specific tax, which varies with q, affect’s a firm’s VC but not its F. As a result, it affects the firm’s AC, AVC, and MC but not AFC.

72
Q

How does a specific tax affect the AVC curve?

A

At every q, AVC and AC rise by the full amount of the tax. Thus, a firm’s after-tax average variable cost, AVCa, is its average cost of production plus the tax per unit.
AVC* = AVC + t

73
Q

How does a specific tax affect the AC curve?

A

Because the tax increases AVC and doesn’t affect AFC, AC increases by the amount of the tax.
AC* = AC + t

74
Q

How does a specific tax affect the MC curve?

A

MC* = MC + t

75
Q

How does a specific tax affect the MC and AC graphically?

A

The new MC and AC curves are parallel to the old ones, “t” units higher at each q.

76
Q

What is a franchise tax?

A

Also called a business license fee, a franchise tax is a lump sum that a firm pays for the right to operate a business.

77
Q

How does a franchise tax affect a firm’s costs?

A

Franchise taxes don’t vary with q, so they only affect firm’s F.

M i c (7 decks)

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