Chapter 7 - Costs

Question 1

What are accounting costs?

Answer 1

The direct costs that come from operating a business.

Question 2

What are opportunity costs?

Answer 2

What the consumer must give up when it uses an input, eg. what it could have done with it instead.

Question 3

What are economic costs?

Answer 3

The combined opportunity and accounting costs.

Question 4

Why should fixed costs not be taken into account when making production decisions?

Answer 4

They will occur regardless of what they are used for or even if they are used at all.

Question 5

What are sunk costs?

Answer 5

Things which once they have been paid there is no way to recover any of their value eg. license fees.

Question 6

What are operating revenue and costs?

Answer 6

What is earned by selling a product vs what it costs to make it. A business should only continue to operate if revenue > costs.

Question 7

What is the equation for total costs?

Answer 7

TC = FC + VC

Question 8

How are costs defined as either fixed or variable?

Answer 8

They are categorized depending on how easy it is for the firm to change the amount of input it is using.

Question 9

Why are most costs fixed in the SR?

Answer 9

In a day/week it is very difficult to change the amount of labour or capital being used whereas in a longer period of time costs will gradually become variable.

Question 10

What does a cost curve show?

Answer 10

The relationship between a firms production costs and its output over a specific period of time.

Question 11

What are the 3 types of average cost?

Answer 11

1. Average total cost
2. Average variable cost
3. Average fixed cost

Question 12

What is average fixed cost?

Answer 12

It is simply fixed cost divided by output, as fixed costs remain the same higher quantities produced will cause it to decrease.

Question 13

What is average variable cost?

Answer 13

It is the per unit cost of production divided by the quantity produced.

Question 14

What is average total cost?

Answer 14

It is the average overall cost per unit, it is found by adding AVC and AFC at a given output level.

Question 15

What is marginal cost?

Answer 15

Marginal cost is how much it will cost overall to produce an extra unit of output.

Question 16

How is marginal cost calculated?

Answer 16

It is calculated by finding the change in total cost divided by the change in quantity.

Question 17

What is marginal cost also equal to?

Answer 17

As fixed costs do not change it is also equal to the change in variable costs divided by the change in output.

Question 18

What will the marginal cost curve look like?

Answer 18

For the first few units the curve may decline due to learning by doing however there after it will begin to increase due to reasons such as decreasing returns to scale, increased cost of materials, diminishing MRTSlk and capacity constraints

Question 19

What costs are both derived from total cost and thus related?

Answer 19

Average cost and marginal cost.

Question 20

What does it mean if marginal cost is less than average cost?

Answer 20

If marginal cost is less than average cost then the next unit produced unit will cost less than all the units which have been made before it and thus will decrease average cost overall.

Question 21

What does it mean when the marginal cost curve is below average cost?

Answer 21

Costs must be falling and the curve will be downward sloping. This is even true when marginal costs are rising.

Question 22

Why are the points where marginal costs and average cost are equal important?

Answer 22

At these points, there will be no change in average cost from producing an additional unit however after these points marginal costs will begin to increase average costs.

Question 23

What does the SR expansion path look like?

Answer 23

It will be a horizontal line extending from the fixed level of capital.

Question 24

What will the LR expansion path look like?

Answer 24

It will curve upwards with points lying on the optimal production bundles.

Question 25

What are SR and LR total cost curves?

Answer 25

They are similar to Engel curves and will show how input changes with cost.

Question 26

What are economies of scale?

Answer 26

If a proportional increase in the amount of output was to cause a less than proportional increase in costs then this would be economies of scale.

Question 27

What are constant economies of scale/diseconomies of scale?

Answer 27

When a proportional increase of all inputs causes the same increase or a greater than proportional increase in costs.

Question 28

What do economies of scale imply?

Answer 28

That the LR ATC falls as output increases and thus the curve will be downwards sloping as ATC = TC/Q.

Question 29

What do diseconomies of scale imply?

Answer 29

That the ATC curve will be upward sloping.

Question 30

What do constant economies of scale imply?

Answer 30

That the ATC curve is flat at that point.

Question 31

What will an ATC curve typically look like?

Answer 31

It will be U shaped. At low output levels cost is rising more slowly than output causing it to fall, at the bottom of the curve TC is rising proportionally with output and thus MC = ATC, at higher output levels MC exceeds ATC causing TC to rise quicker.

Question 32

What is the difference between economies of scale and returns to scale?

Answer 32

Returns to scale is a measure of how outputs change with a change in input whereas economies of scale is a measure of how costs change with an increase in output.