8.1 Costs

Question 1

Short Run

Answer 1

A period of time where at least one factor of production is fixed

Question 2

Long Run

Answer 2

A period of time where all factors of production are variable

Question 3

Law of Diminishing Returns and Short Run Costs

Answer 3

The law of diminishing returns states that in the short run, as variable factors of production are added to a stock of fixed factors of production, total/marginal output will initially rise and then fall due to the law of diminishing returns.

Question 4

Draw diagram

Law of Diminishing Returns and Short Run Costs: Variable Factor

Answer 4

The variable factor is assumed to be labour and the fixed factors are land and capital. By adding more labour, initially there are productivity improvements as under utilised fixed factors are used up and sepcialisation gains take place. This leads to an initial rise in marginal product and fall in marginal cost, stage 1. Eventually however, when more workers are hired they get in the way of one another, with the fixed factors of production constraining production. Therefore labour productivity falls, reducing marginal product and increasing marginal cost, stage 2.

Question 5

Draw the diagram

Long Run Costs and Returns to Scale

Answer 5

In the long run all factors of production are variable where the return on investment decisions when increasing output is needed to understand the average cost relationship. The long run average cost curve is shaped due to increasing and decreasing returns to scale as a result of economies and diseconomies of scale. The minimum efficient scale of production occurs where full economies of scale have been exploited.

Question 6

Internal Economies of Scale

Answer 6

As output rises, long run average costs fall due to internal economies of scale.

Question 7

Internal Economies of Scale: Financial Economies

Answer 7

Financial Economies. This is where large firms are able to negotiate lower rates of interest on loans for investment projects. This is because large firms have a track history of success and are therefore less risky to lend money to. Once more, firms will be borrowing a huge sum of money, which does not significantly increase the marginal costs for a bank, thus keeping interest rates low. Consequently, tola costs are rising but more slowly than output reducing the unit cost of production.

Question 8

Internal Economies of Scale: Marketing Economies

Answer 8

Marketing Economies. This is where large firms are able to use their size and dominance in the market to negotiate bulk deals and discounts when marketing Consequently, total costs are rising but more slowly than output reducing the unit cost of production.

Question 9

Internal Economies of Scale: Technical Economies

Answer 9

Technical Economies. This is occurs as firms grow in a size and are able to purchase highly specialist machinery to enhance their production. As a consequence, the productivity of capital increases where output rises faster than total costs reducing average costs and thus the unit cost of production. Furthermore technical economies of scale also refers to dividing up the labour force making workers specialise with individual tasks. This will boost productivity Increasing output much faster than total costs, reducing unit costs.

Question 10

Internal Economies of Scale: Managerial Economies

Answer 10

Managerial Economies. A large firm is able to employ specialist managers to improve the productivity of workers in a business. This improvement in productivity will increase output more than total costs thus reducing unit costs

Question 11

Internal Economies of Scale: Purchasing Economies

Answer 11

Purchasing Economies. This occurs when a firm is able to purchase raw materials and component parts in bulk and thus negotiate a large discount per unit. This means that total costs will be rising but at a slower rate than output, reducing the unit cost of production.

Question 12

External Economies of Scale

Answer 12

Occur outside a firm but within an industry, and as a business becomes larger, external economies of scale can reduce the cost of production.

Question 13

External Economies of Scale: Improvement in transport infrastructure

Answer 13

improvement in transport infrastructure. As a business becomes larger, transport infrastructure may improve in the locality of a business, reducing the costs of production for the business, consequently decreasing total costs and thus the unit cost of production

Question 14

External Economies of Scale: Material suppliers move closer

Answer 14

Material suppliers move closer to where a business is located. As a business grows in size there is a greater chance of material suppliers moving closer to the location of business which would reduce the cost of accessing raw materials reducing total costs and thus the unit cost of production.

Question 15

External Economies of Scale: Research and Development firms move close

Answer 15

As a business grows in size there is a greater chance of R&D hubs developing close by, with businesses benefiting from the innovation and research and development that can reduce their total costs and/or increase the productivity of their capital thus reducing the unit cost of production

Question 16

Diseconomies of Scale

Answer 16

As output rises, long run average costs rise due to diseconomies of scale.

Question 17

Diseconomies of Scale: Communication

Answer 17

When a business becomes so large, managers find it increasingly difficult to monitor and communicate with their staff. With managers having more staff in their team to manage and monitor, workers will realise the difficulty and shirk more at work reducing productivity thus increasing total costs more than out thus increasing unit costs.

Question 18

Diseconomies of Scale: Coordination

Answer 18

Coordination. The larger the business, the more layers of management and bureaucracy are added making it more difficult to coordinate business plans and strategies from the top to the bottom of a hierarchy. Once more it makes it harder for ideas to feed through the appropriate channels before becoming a reality. The increased time taken to streamline the production process reduces efficiency and productivity, which increases average costs as total costs rise by more than output.

Question 19

Diseconomies of Scale: Motivation

Answer 19

Motivation. The larger a business becomes, the more workers feel alienated and a less significant part of the workforce. This demotivates them and impacts their morale reducing productivity thus increasing average costs as total costs rise by more than output.