cost curves

Question 1

Describe and account for the shape of an average fixed cost curve and an average variable cost curve.

Answer 1

Total fixed costs do not change as output changes – one mark.
Average fixed costs are TFC divided by output – one mark.
Therefore an average fixed cost curve falls continuously as output is increased – one mark.
This is because the fixed costs are being divided by a bigger and bigger output – one mark.
A maximum of 4 marks.
Variable costs are costs that vary directly with output – one mark.
Average variable costs are TVC divided by output – one mark.
As output increases the average variable cost curve falls at first – one mark as the firm is experiencing increasing (average) returns to the variable factor/the average output of the variable factor is increasing – one mark.
However the AVC curve will eventually start to rise – one mark, when the firm experiences decreasing (average returns) to the variable factor/the average output of the variable factor decrease

Question 2

Explain, using a diagram, what happens to a firm’s average total costs in the short run.

Answer 2

ATC is U-shaped. ATC falls and then rises as output increases. (1 mark)
The shape of the ATC curve in the SR is determined by the shape of the AFC + AVC added together (1 mark)
AFC falls over its entire length as a constant is spread over its entire length (1 mark)
AVC falls and then rises because of initially increasing returns and ultimately diminishing returns (1 mark)
When the rise in AVC outweighs the fall in AFC then ATC will rise (1 mark)
The diagram should have (1 mark) for the ATC curve accurately depicted.
(1 mark) for axes correctly labelled.

Question 3

Explain, using a diagram, the relationship between marginal costs and average total costs.

Answer 3

clear explanation of why it is inevitable that MC lower than ATC leads to a falling ATC, and why MC higher than ATC pulls the ATC curve upwards.

Question 4

Explain, using a diagram, the shape of a long run average cost curve.

Answer 4

AC falling demonstrates economies of scale (ID) ie the firm benefits from cost advantages due to its size/output/scale of operation. (1)
AC falls because increasing inputs leads to a more than proportionate increase in output (increasing returns to scale). (1 development mark)
When AC reaches its lowest point (ID) the firm has reached its minimum efficient scale/maximum efficiency/constant returns to scale. (1)
External economies of scale e.g. growth in size of industry reducing costs.
Taxation e.g. new taxes drive up costs and shift LRAC upwards
Technology e.g. LRAC based on assumption technology is constant – improvements would reduce costs and push LRAC down.

Question 5

Economies of scale

Answer 5

Technical
Increased division of labour and specialisation, efficient use of capital e.g. car assembly line etc.
Managerial
Able to employ specialists as there is sufficient work

Financial
Easier to attract investors due to reduced risk, higher reputation and able to borrow money at lower rates of interest

Question 6

Diseconomies of scale

Answer 6

management/coordination
As a firm grows it acquires more workers and departments and so it is Difficult for management to keep control of activities of organisation

Geography
Business is too spread out leading to increased costs of transportation or lack of control (e.g. HQ being too far away)

Waste
Unnecessary waste pushes cost up e.g. over-manning/stealing

Question 7

external economies of scale

Answer 7

cost savings due to the increased size of the industry (1)

transportation infrastructure provided by local authority