Chapter 7: The Cost Of Production

Question 1

The _____ combinations are chosen

Answer 1

The best or optimal (cost minimising)

Question 2

What is the difference between economic and accounting cost

Answer 2

Accounting cost - actual expenses plus depreciation charged for capital equipment

Economic cost - cost to a firm of utilising economic resources in production

Question 3

Explain opportunity cost

Answer 3

It is the cost associated with opportunities forgone when a firms resources are not put to their best alternative use

Economy cost = Opportunity cost

Question 4

What’s the difference between sunk costs and prospective sunk cost

Answer 4

Sunk costs - expenditure that has been made and cannot be recovered

Prospective sunk cost - not yet incurred the cost but is considering it

Question 5

Differentiate between total cost, fixed cost and variable cost

Answer 5

Total cost - is the total economic cost of production, consisting of fixed and variable costs

Fixed cost - is the cost that does not change/vary with the level of output and that can be eliminated only by shutting down

Variable cost - cost that varies as output varies

Question 6

When do cost from fixed to variable

Answer 6

In the long run

Question 7

What is amortisation

Answer 7

Policy of treating a one time expenditure as an annual cost spread out over some number of years

Question 8

What is a marginal cost

Answer 8

Increase in cost resulting from the production of one extra unit of output

Question 9

Explain diminishing marginal returns

Answer 9

Diminishing marginal returns means that the marginal product of labour declines as the quantity of labour employed increases.

As a result, when there are diminishing marginal return, marginal cost will increase as output increases and vice versa

Question 10

How can a firm expand its capacity in the long run

Answer 10

By expanding existing factories or building new ones

Question 11

What is the user cost of capital

Answer 11

Annual cost of owning and using a capital asset (= economic depreciation + forgone interest)

Question 12

What is a fundamental problem that all firms face

Answer 12

How to select inputs to produce a given output at minimum cost

Question 13

What is the expansion path

Answer 13

Curve passing through points of tangency between a firms isocost lines and its isoquants

Question 14

What is the most important determinant of the long run average cost curve and marginal cost curve

Answer 14

It is the relationship between the scale of firms operations and input required to minimise costs

Question 15

What is the long run marginal cost curve

Answer 15

It is the curve showing the change in long run total cost as output is increased by one unit

Question 16

What is the difference between the short run and long run average cost curve

Answer 16

The SAC - it is a curve relating average cost of production to output when level of capital is fixed

The LAC - it is a curve relating average cost of production to output when all inputs including capital are variable

Question 17

Differentiate between economies and diseconomies of scale

Answer 17

Economies of scale - as output increases the firms average cost of producing that output is likely to decline at least to a point (output can be doubled for less than a doubling of cost

Diseconomies of scale - at some point it is likely that average cost of production will begin to increase without output (doubling of output requires more than a doubling of cost)

Question 18

What are the reasons for economies of scale

Answer 18

1. if the firm operates on a larger scale, workers can specialise in activities that wish their most productive
2. Scale can provide flexibility. By varying the combination of inputs utilised to produce the firms output managers can organise the production process more effectively.
3. The firm may be able to acquire some production input at lower cost because it is buying them in large quantities and therefore can negotiate better prices

Question 19

What are the reasons for diseconomies of scale

Answer 19

1. In the short run, factory space and machinery may make it difficult for workers to do their jobs effectively
2. Managing a larger firm may become more complex and inefficient as the number of tasks increase
3. The advantages of buying in bulk may have disappeared once certain quantities are reached, at some point available supplies of key inputs may be limited therefore pushing their costs up

Question 20

What is a product transformation curve

Answer 20

Curve showing the various combinations of two different outputs(products) that can be produced with a given set of inputs

Question 21

Differentiate between economies of scope and diseconomies of scope

Answer 21

Economies of scope - situation in which joint output of a single firm is greater than output that could be achieved by two different firms when each produces a single product

Diseconomies of scope - situation in which joint output of a single firm is less than output that could be achieved by separate firms when each produces a single product

Question 22

What are the reasons that the long run average cost curve decreases

Answer 22

If firms average cost of production can decline overtime because of growth in sales when increasing returns of present or it can decline because there is a learning curve

Question 23

What are the reasons that the long run average cost curve decreases in relation to the learning curve

Answer 23

1. As workers adapt their speed increases
2. Managers learn to schedule the production processes more effectively
3. Engineers who are initially cautious in the product designs may gain enough experience to be able to allow for tolerances in design
4. Suppliers may learn how to process required materials more effectively