Costs

Question 1

What Are Costs?

Answer 1

They are payments for factor services used to produce a good or service.

Question 2

What Is The Short Run?

Answer 2

A situation where at least one factor of production is fixed. This is usually land, technology or capital.

Firm can only increase output by increasing units of the variable factors.

Question 3

What Is The Short - Run Production Function?

Answer 3

It shows the relationship between factors of production a firm uses and the output it produces. At least one of the factors is in fixed supply.

Question 4

What Are Types Of Short Run Costs?

Answer 4

Fixed Costs

Variable Costs

Question 5

What Are Fixed/Overhead Costs?

Answer 5

Costs that do not vary with output.

Examples Include:
Rent
R & D
Advertising Costs
Insurance Premiums.

Question 6

What Are Sunk Costs?

Answer 6

Costs that can’t be recovered when a firm stops production.

Some fixed costs are sunk costs.

Question 7

What Are Variable Costs?

Answer 7

Costs that vary directly with output. They are also called direct or prime costs.

Examples Include:
- Raw materials
- Labour Costs

Question 8

What Are Types Of Short - Run Costs?

Answer 8

Total Cost (TC)
Average Fixed Costs (AFC)
Average Variable Costs (AVC)
Average Total Cost (ATC)
Marginal Cost (MC)

Question 9

What Are Total Cost?

Answer 9

The sum of fixed costs and variable costs.

Formula : TC = FC + VC
OR. TC = TFC + TVC

Question 10

What Is Marginal Cost?

Answer 10

The increase in total cost when one more unit of output (Q) is produced.

This is a variable cost.

Formula : MC = ∆TC ÷ ∆Q

MC will fall initially due to increasing returns to the variable factor and then rise when diminishing marginal returns set in.

Question 11

What Are Average fixed cost (AFC)?

Answer 11

Fixed cost per unit of output.

AFC = TFC/Q

AFC fall throughout as output increases because the fixed cost is spread over an increasing number of units of output.

Question 12

What Is Another Name For Average Costs?

Answer 12

Unit Costs

Question 13

What Are Average Variable cost (AVC)?

Answer 13

Variable cost per unit of output.

Formula: AVC = TVC/Q

AVC fall initially due to increasing returns to the variable factor and eventually rise when diminishing marginal returns set in.

Question 14

What Are Average Total cost (ATC or AC)?

Answer 14

The sum of the average fixed cost and average variable cost.

Formula : ATC = AFC + AVC
or
TC/Q

ATC will fall initially as both AFC and AVC fall. It will eventually rise when diminishing marginal returns cause AVC to rise. Thus the ATC curve is ‘U’ shaped.

Question 15

What Is The Relationship Between MC, TC, AVC and ATC ?

Answer 15

When MC is falling TC increases at a decreasing rate. Both AVC and ATC fall.

When MC is rising TC increases at an increasing rate. Both AVC and ATC rise.

The MC curve crosses both the AVC and ATC curves at their lowest points.

Question 16

What Is Total Product?

Answer 16

Output (units) produced by a given number of factor inputs over a period of time. It is also called total physical product (TPP).

Question 17

What Is Marginal Product?

Answer 17

The additional unit(s) of output produced when one extra factor input is employed also known as marginal physical product (MPP).

Marginal product is the gradient of the TP curve

Formula: Marginal product = ∆ Total product ÷ ∆ Variable factor input

Question 18

What Is The Average Product?

Answer 18

Output per factor input, also known as the average physical product (APP).

Formula : Average product = Total product ÷ total variable factor inputs

Question 19

What Is The Long Run Production Function?

Answer 19

It shows the relationship between the factors of production and the output a firm produces. The firm can adjust all its factors of production.

Question 20

What Is The Long Run?

Answer 20

A period of time/ situation where all factors of production and costs are variable.

The firm can change its scale of production. Technology also changes in the long run.

Question 21

What Is The Long- run Average Total Cost Curve?

Answer 21

It is an envelope curve for all short-run ATC curves which shows the lowest cost combination of
factor inputs of production at different levels of output.

Each short run cost curve corresponds to a different size of the firm. It is tangential to the short-run ATC curves.

Question 22

What Are Returns To Scale?

Answer 22

It is a measure of the percentage change in output resulting from a percentage change in all factor inputs.

Question 23

What Are Types Of Returns To Scale?

Answer 23

Increasing returns to scale
Decreasing returns to scale
Constant returns to scale

Question 24

What Are Increasing Returns To Scale?

Answer 24

This where output increases at a proportionately faster rate than the increase in factor inputs.

ATC falls.

Question 25

What Are Decreasing Returns To Scale?

Answer 25

This is where factor inputs increase at a proportionately faster rate than the increase in output.

ATC rises.

Question 26

What Are Constant Returns To Scale?

Answer 26

A percentage increase in factor inputs leads to the same proportionate increase in output.

ATC remains constant.

Question 27

What Is The Minimum Efficient Scale (MES)?

Answer 27

It is the level of output at which the lowest long run average costs begin.

It is also known as the optimum level of production.

Question 28

What Is The Relationship Between The Short-run Average Cost Curve And The Long-run average Cost Curve?

Answer 28

In the short-run average costs fall at first and then rise because of diminishing returns.

In the long-run, average costs change because of economies and diseconomies of scale. The
firm can choose the profit-maximising scale of production and move to lower short-run average
cost curves by changing its factor inputs.

The long-run AC curve contains all the associated short-run AC curves with some element of diminishing returns. It is an envelope for the short- run AC curves.