Costs

Question 1

How are economic costs different?

Answer 1

Economist use, economic costs or opportunity costs to evaluate the cost of resources

Question 2

What is an implicit cost?

Answer 2

Opportunity costs.

Question 3

What is an explicit cost?

Answer 3

Out of pocket costs for the firm. E.g Cost of acquiring labour, capital, energy and materials.

Opp cost is simply the market price

Question 4

What is capital?

Answer 4

A durable good which provides services over a long period (land, equipment, buildings) used for further production

Question 5

How do you measure opportunity cost of capital when capital is rented?

Answer 5

Simply the rental price.
Even if capital is purchased, the opp cost of using capital is the amount a firm could earn by renting it out to someone else so they can still use market rental rate to measure cost of capital.

Question 6

What are fixed costs?

Answer 6

(F) Costs that do not vary with the level of output q

Question 7

What is an example of fixed cost?

Answer 7

Rent, salaries of permanent employees

Question 8

What are variable costs ? (VC)

Answer 8

Costs that vary with the level of output

Question 9

What are variable costs?

Answer 9

Raw materials, labour (not always fully variable but assume for simplicity)

Question 10

Total costs or just costs (C) are?

Answer 10

The sum of fixed and variable costs

Question 11

What is the formula for C

Answer 11

C = F + VC

Question 12

What are marginal costs?

Answer 12

Change in total costs if the firm produces an additional unit of output

Question 13

Formula for MC?

Answer 13

Change in total cost/change in Q
Or
dC(q)/dq

Question 14

AFC formula?

Answer 14

Fixed costs/Quantity

Question 15

Trend of average fixed costs as output increases?

Answer 15

AFC always fall as output increases as fixed costs are spread over more units

Question 16

What is AVC formula

Answer 16

VC/Q

Can increase or decrease with output

Question 17

What is average total cost or average costs AC?

Answer 17

AC = AFC + AVC

Question 18

What determines shape of short run cost curve?

Answer 18

Short run production function

Question 19

What is MC in the SR cost curve?

Answer 19

MC = w / MP(L)

Question 20

How do firms produce a given quantity of output at minimum cost?

Answer 20

Firms use information about their production functions and the price of production factors

Question 21

What info do firms use to produce a given quantity of output at minimum cost?

Answer 21

Short run: only vary the amount of labour
Long run: can vary both capita and labour inputs

So long run costs will never be higher than short run costs!

Question 22

What is an isocost line?

Answer 22

An isocost line shows combinations of inputs that require the same total cost

Question 23

Isocost lines are similar to budget constraints but?

Answer 23

Consumers have one budget constraint only (determined by income and prices)
Firms have many isocost lines

Question 24

What are the 3 properties of isocost lines?

Answer 24

• The firms cost level, c̅, and input prices determine where the isocost line hits the axes
• isocost further from the origin have higher costs than those closer
• slope of each isocost is the same and given by the relative prices of the inputs

Question 25

For a desired level of output, which isocost does the firm choose?

Answer 25

A firm chooses the isocost line that minimizes its total cost for a desired level of output. In other words, the firm selects the combination of inputs (such as labor and capital) along the isocost line that allows it to produce the desired output at the lowest possible cost. This point of minimum cost is where the isocost line is tangent to the isoquant curve, representing the most cost-effective input combination for the given production level.

Question 26

How is the isocost line related to the isoquant?

Answer 26

Isocost line is straight sloping down and isoquant is curved sloping down

Question 27

Isoquant vs isocost line

Answer 27

• Isoquant: Represents all the combinations of inputs (like labor and capital) that produce the same level of output.
• Isocost Line: Shows all the combinations of inputs that a firm can afford given a particular cost or budget.

Question 28

What do firms do when factor price changes?

Answer 28

Firms substitute away from the now relatively more expensive factor

E.g. if wages go down,

Isocost line becomes flatter
Standard convex isoquants - firms substitute away from capital and towards labour

Question 29

How do we derive a firm’s long run expansion path and its long run cost curve?

Answer 29

Repeating the process of “finding cost minimising combination of inputs for a given output level”, for different output levels

Question 30

How to derive a long run expansion path?

Answer 30

Curve through tangency points between isocost lines and isoquants for different levels of output

Question 31

How to derive a long run cost curve?

Answer 31

Derived from long run expansion path

Question 32

What does production function determine?

Answer 32

Shape of SR & LR cost curves

Question 33

A cost function exhibits economies of scale if average costs …?

Answer 33

Economies of scale if average costs fall as output goes up

Question 34

When does economies of scale (avg cost fall as output increase) happen for fixed Factor prices?

Answer 34

For fixed factor rices this happens if underlying production function has IRS (inc returns to scale)

Or doubling all inputs

Question 35

When does a firm exhibit diseconomies of scale?

Answer 35

If average costs rise as output rises.

Also if underlying production function has decreasing returns to scale DRS

Question 36

Why do we often find a U shaped or L shaped pattern for avg costs as output goes up?

Answer 36

• increasing then decreasing returns to scale
• this is because the shape of long run cost curves is determined by the shape of the production function

Question 37

What happens in a U shaped pattern for average costs?

Answer 37

First decreasing average costs as we are on the IRS part of production function, then increasing average costs as we move to the DRS part

Question 38

What happens in an L shaped avg cost pattern?

Answer 38

First decreasing, then constant average costs
(IRS -> CRS)

Question 39

In the long run costs cannot?

Answer 39

Cannot be higher in the LR than the SR

Question 40

Why can’t long run costs be higher than in the short run?

Answer 40

We can’t vary capital in the short run so we might have to produce with a suboptimal level of capital.

Also the firm could always choose same level of capital stock as in the short run so they never can be worse of in the long run.

Question 41

A firms cost in the SR can be described using?

Answer 41

Cost-level curves [Total, fixed & variable]
And cost-per-unit curves [Average total, Average fixed and AVC, MC]

Question 42

Given constant input prices, the shapes of cost curves are determined by a firm’s…?

Answer 42

Production function