Cost and Economies of Scale Flashcards
Explain and calculate Fixed costs
○ Fixed costs:
○ Costs which do not vary with output
○ E.G. Rent/Advertising
Calculation:
Total Fixed Costs = Total costs - total variable costs
Explain and calculate variable costs
○ Variable Costs:
○ Costs which change with output (Direct Costs)
○ E.G. Raw materials
Calculation:
Total variable costs = Total costs - total fixed costs
Explain and calculate total costs
Total Costs:
○ Costs to produce a given level of output
○ Calculated:
□ Total Costs = Total Fixed Costs + Total Variable Costs
Explain and calculate average costs
○ Average Costs:
○ The cost per unit
○ Calculated:
□ Average Costs = Total Costs/Quantity Produced
Explain and calculate marginal costs
○ Marginal Costs:
○ The cost of producing one extra unit
○ Calculated:
□ Relationship between SRAC and LRAC
Explain Short run in terms of variable and fixed factors
○ Short Run Average Costs (SRAC):
○ At least one factor of production cannot change
○ Therefore there are some fixed costs
○ Fixed costs do not vary with output
○ E.G. Rent/Advertisement
Explain long run in terms of variable and fixed factors
○ Long Run Average Costs (LRAC)
○ All factors of input can change
○ Therefore all costs are variable
○ E.G. Production moves factories
Explain The difference between marginal, average and total returns:
○ Marginal:
§ Marginal return of a factor is the extra output derived per extra unit of the factor employed
§ E.G. Labour, extra output per extra worker employed
○ Average:
§ The average return of a factor is the output per unit of input
○ Total:
§ The total return of a factor is the total output produced by a number of units of factors over a period of time
The amount of capital is fixed
Explain the Law of Diminishing Returns
○ Only occur in the short run
○ Variable factor can be increased in the short run:
□ Firms employ more labour
□ Overtime the labour becomes less productive
□ Therefore marginal return of labour falls
□ An extra worker would add less to the total output than before
□ Therefore total output still rises but at a slower rate than before
□ This is linked to how productive labour is
○ The law assumes that firms have fixed factor resources in the short run
○ Therefore assuming the state of technology remains constant
However, things such as out-sourcing could mean that firms can cut their costs and production be more flexible
○ Overall:
§ At some point in the production process adding more input leads to a fall of marginal output
Explain Returns to scale; Increasing, Decreasing and constant returns to scale:
§ Returns to scale refers to the change in output after an increase in factor inputs
§ Returns to scale increases if the output increases by a greater proportion than the increase in inputs
§ Returns to scale decreases if the output increases by a lower proportion than the increase in inputs
§ Returns to scale remains constant if output and input increase at the same amount (E.G. Input doubles and so does output)
Explain with the aid of a diagram, Internal economies of scale
- Internal Economies of Scale:
○ Really Fun Mums Try Making Pies
□ R - Risk Bearing - When a firm becomes larger they can increase their production range, therefore spreading the cost of uncertainty
□ F - Financial - Banks are willing to lend larger loans more cheaply to larger firms as they are seen as less risky. Therefore larger firms take advantage of cheaper credit
□ M - Managerial - Larger firms are more able to specialise and divide their labour
□ T - Technological - Larger firms can afford to invest in more advanced and productive technology/machinery and capital which can lower their average costs
□ M - Marketing - the average cost of advertising per unit is smaller than that of a smaller firm
□ P - Purchasing - Larger firms have more money and therefore can afford to buy more, leading to bulk buying discounts, allowing for lower costs of production
○ Network Economies of Scale:
□ This is gained from the expansion of commerce
Explain External Economies of Scale:
○ These occur within the industry
○ E.G. Local roads are improved, therefore lower transport costs and therefore lower industry costs of production
○ More training facilities or R&D facilities in the local area decreasing costs
Explain with the aid of a diagram, Diseconomies of Scale
- This occurs when output passes a certain price and AC start to increase per extra unit of output produced
- E.G.:
○ Control:
□ It becomes harder to monitor the productivity of a workforce once it becomes larger
○ Coordination:
□ Harder and more complicated to coordinate every worker, especially when there are thousands of employees
○ Communication:
□ Workers start to feel excluded as the firm grows
□ Could lead to a decrease in productivity and therefore an increase in average costs
- E.G.:
Explain with the aid of a diagram, Diseconomies of Scale
- This occurs when output passes a certain price and AC start to increase per extra unit of output produced
- E.G.:
○ Control:
□ It becomes harder to monitor the productivity of a workforce once it becomes larger
○ Coordination:
□ Harder and more complicated to coordinate every worker, especially when there are thousands of employees
○ Communication:
□ Workers start to feel excluded as the firm grows
□ Could lead to a decrease in productivity and therefore an increase in average costs
- E.G.:
Explain with the aid of a diagram, Diseconomies of Scale
- This occurs when output passes a certain price and AC start to increase per extra unit of output produced
- E.G.:
○ Control:
□ It becomes harder to monitor the productivity of a workforce once it becomes larger
○ Coordination:
□ Harder and more complicated to coordinate every worker, especially when there are thousands of employees
○ Communication:
□ Workers start to feel excluded as the firm grows
□ Could lead to a decrease in productivity and therefore an increase in average costs
- E.G.:
