Chapter 11: Firm Behaviour - Short Run Costs

Question 1

What are total fixed costs? (2)

Answer 1

• do not vary with changes in output
• have to pay even if the firm produces zero

Question 2

What are some examples of total fixed costs?

Answer 2

rent, contracted salaries, interest on debts, insurance

Question 3

What are total variable costs?

Answer 3

• changes with changes in output

Question 4

What are some examples of TVC?

Answer 4

wages, cost of material inputs, fuel, power

Question 5

What is the formula for total costs

Answer 5

TC = TFC + TVC

Question 6

Average Fixed Costs (AFC) formula

Answer 6

AFC = TFC/Q

Question 7

Average Variable Cost (AVC) furmula

Answer 7

AVC = TVC/Q

Question 8

Average total cost (ATC) formula

Answer 8

ATC = AFC + AVC = TC/Q

Question 9

What is marginal cost?

Answer 9

• the extra, or additional cost of producing one more unit of output

Question 10

Marginal cost formula

Answer 10

MC = change in TC / change in Q

Question 11

Graph with MC, ATC, AVC, AFC

Answer 11

Question 12

What is the relationship between average and marginal costs? (3)

Answer 12

if avg cost is rising, marginal cost must be ABOVE the average cost
- if avg cost is falling, marginal cost is below avg cost
- so on graph, MC always cuts AC at the minimum AC

Question 13

Increasing the output has two opposing effects on average total cost. What are these effects called?

Answer 13

• spreading effect
• the diminishing returns effect

Question 14

What is the spreading effect?

Answer 14

• the larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower the average fixed cost

Question 15

What is the diminishing returns effect?

Answer 15

• the larger the output, the greater the amount of variable input required to produce additional units, leading to higher average variable cost

Question 16

We observe that marginal product intersects AP at max AP, and marginal cost intersects ATV and AVC at their minima. What is the relationship? (3)

Answer 16

• when productivity is at its highest, costs are least
• MC is the inverse of marginal product
• AVC is the inverse of AP

Question 17

What are three important price levels?

Answer 17

• shutdown price
• loss price
• Break Even point

Question 18

What is the shutdown price?

Answer 18

• if the price falls below A, the firm is better off shutting down

Question 19

What is the loss price?

Answer 19

• if the price is between A and B, the firm produces in the short run, covering variable costs
• it will shut down in the long run

Question 20

What is the break even point?

Answer 20

• if the price is above B (break even) the firm continues to produce and earns positive economic profit

Question 21

What is a sunk cost?

Answer 21

• a fixed cost that cannot be recovered, even via a shutdown

Question 22

If a firm cannot make a profit, should it shut down?

Answer 22

• if it can cover its variable costs, having already sunk its fixed costs, it should stay in production