costs

Question 1

what is the definition of short run?

Answer 1

• a period of time in which at least 1 factor of production used in the production process of a firm cannot be varied

Question 2

what makes up short run cost?

Answer 2

(SR) TC = TFC + TVC

Question 3

how do we obtain average cost (AC)?

Answer 3

• dividing the total cost by the firm’s output

Question 4

what is the definition of the marginal cost (MC) of production of a firm?

Answer 4

• it is defined as the addition to total cost (LR)/ total variable cost (SR) due to the increase in production of 1 additional unit of output

Question 5

where does the MC curve intersect the AC & AVC curve?

Answer 5

• at their respective minimum points

Question 6

are the AC curve & AVC curve parallel to each other?

Answer 6

• NO

Question 7

why are the AVC & AC curves not parallel to each other?

Answer 7

because the vertical distance between the AC curve & AVC curve represents the AFC, which is continuously falling as the firm’s output increases

Question 8

what is the definition of long run?

Answer 8

• there are no fixed factors of production, so the firm is able to vary the quantities of any factor inputs in order to produce different quantities of output, should it choose to

Question 9

what makes up long run cost?

Answer 9

TC = TVC

Question 10

what is the Law of Returns to Scale?

Answer 10

• it tells us that at low levels of output, increasing all factor in puts at the same rate will result in an increase in output at a higher rate

Question 11

so why does the LRAC fall as output of a firm rises intitially?

Answer 11

• due to increasing returns to scale!!
• as output rises more quickly than inputs, the average & marginal costs of producing subsequent units will fall

Question 12

why does the LRAC eventually rises as output rises, due to decreasing returns to scale?

Answer 12

• at higher output levels, there is decreasing returns to scale, where output rises slower than inputs
• as a result, the LRMC & LRAC will slope upwards

Question 13

what is the lowest point on the LRAC curve known as?

Answer 13

• minimum efficient scale (MES)

Question 14

what is the significance of the MES?

Answer 14

• it is the output level that allows the firm to enjoy the greatest cost savings,
• & thus incur the lowest possible LRAC, given current technology & input prices