Costs

Question 1

What are economic costs?

Answer 1

• Economic consider all costs relevant for an economic decision: explicit + implicit (op cost of next best alternative) but not including sunk costs

Question 2

If we assume all inputs can be sold in competitive markets: econ. costs =

Answer 2

= opportunity costs = market value

Question 3

What are accounting costs?

Answer 3

• only explicit

- = historical values

Question 4

What is true of labour costs?

Answer 4

• Econ & Acc. costs similar

- Assume w = amount that can be paid in next best alternative employment

Question 5

What is true of capital costs?

Answer 5

• Econ & acc. costs differ

- Economists generally consider large K costs as sunk

Question 6

What are entrepreneurial costs?

Answer 6

• Starter/Owner of business is entitled to some share of profits/loss = wage they would get elsewhere

Question 7

What is the definition, slope and intercepts of an isocost?

Answer 7

• Different combinations of K and L that give the same TC
• slope: -w/v i.e. linear
• Intercepts: TC/v TC/w

Question 8

In cost minimisation, what assumption do we make about inputs and what is the implication?

Answer 8

• Assume both hired in perfectly competitive input markets
  
  • w = VMPL
  • v = VMPK
  • i.e. both having horizontal supply curves at w and v

Question 9

In Cost min, TC =

Answer 9

= wL + vK

Question 10

In Cost min, TR =

Answer 10

= pq = pf(K,L)

Question 11

In Cost min, π =

Answer 11

TR - TC = pf(K,L) - wL - vK

Question 12

In the cost min model, what is done first?

Answer 12

• Fix output at given amount : q0
  
  • π = pq0 - wL - vK
  • Price constant and exogenous quantity, firm can only profit maximise by minimising costs

Question 13

Where does cost min occur?

Answer 13

• Cost minimising bundle of K & L is where isocost is tangent to isoquant
• w/v = MRS (= MPL/MPK = K/L)
• MPL/w = MPK/v

Question 14

What is true if MRS > w/v?

Answer 14

use less K and more L

Question 15

What is important about cost min optimisation?

Answer 15

• If MRS = 2,
• if K decrease by 2, need to increase L by 1 unit to stay on same isoquant (b/c MRS!)

etc.

Question 16

What if MPL/w ≠ MPK/v?

Answer 16

• If MPL/w > MPK/v, the additional output from 1 more unit of labour per dollar is greater than the additional output from 1 unit of capital per dollar, and more labour should be hired - hire more productive asset

Question 17

What is an expansion path?

Answer 17

• Shows the cost min bundles of inputs needed as output increases (no change in isocost other than shifts i.e. assume w/v constant)
• Curvature is determined by production function and c/i/d returns to scale
• Shows the relationship between Q and TC

IN Q vs TC SPACE

Question 18

What is a CRTS expansion path?

Answer 18

• Straight line
• q and input use increase proportionally
• TC will also increase accordingly - proportionally

Question 19

What is a DRTS expansion path?

Answer 19

• Exponential line

- As q increases TC increase but a an increasing rate

Question 20

What is an IRTS expansion path?

Answer 20

• Plateuing line
• As q increases TC increases at a decreasing rate
• i.e. need to increase K and L in smaller proportions

Question 21

What is true of a mixed expansion path?

Answer 21

• Efficient scale at tangency point

Question 22

AC =

Answer 22

• AC = TC/Q

Question 23

MC =

Answer 23

• MC = ∆TC/∆Q = ∂TC/∂Q

Question 24

In what space are AC and MC compared with RTS?

Answer 24

$(Y) vs Q(X)

Question 25

What is the relationship in graphical space between AC and MC when there are CRTS?

Answer 25

• Each unit has the same AC = MC

- Straight horizontal lines

Question 26

What is the relationship in graphical space between AC and MC when there are DRTS?

Answer 26

• When TC is increasing at an increasing rate - AC of production is increasing
• MC must lie above AC

Question 27

What is the relationship in graphical space between AC and MC when there are IRTS?

Answer 27

• AC is decreasing as output increases

- MC lies below AC

Question 28

What does increasing AC mean and what does it not mean?

Answer 28

Increasing AC = Diseconomies of scale BUT ≠ DRTS

Question 29

What does decreasing AC mean and what does it not mean?

Answer 29

Decreasing AC = Economies of scale BUT ≠IRTS

Question 30

When we are producing what costs are we interested in?

Answer 30

interested in MC and VC

Question 31

When we are considering entering a market what are we interested in?

Answer 31

MC, VC AND FC

Question 32

What does it mean if we have a fixed input in cost minimisation?

Answer 32

Having a fixed asset means that in the SR, we can’t achieve our cost-min bundle for changing production levels, so cost will be higher than they otherwise would be: SRAC > LRAC

i.e. LMC and LAC lie under SMC and SAC

Question 33

How do we represent having a fixed input in cost minimisation?

Answer 33

K (for instance) stuck on horizontal limit, and cost min tangency must be at the level

Question 34

Specifically what things shift cost curves?

Answer 34

• Input Prices
• Tech
• Economies of Scope

Question 35

What occurs to the expansion path with an increased wage?

Answer 35

• Expansion path for higher L costs pivots towards the K-axis

Question 36

What is true of tech advancement?

Answer 36

Can be equal or biased towards one input

Question 37

How can we tell the RTS from the production function?

Answer 37

• Indices add up to 1 = CRTS

- Indices add up to > 1 = IRTS

Question 38

In a longer form, how can we determine RTS from the production function?

Answer 38

By looking at what happens to output if you increase both inputs proportionally

Question 39

With one input fixed and output given, how can we determine an isoquant (not equation)?

Answer 39

• Devise all different combinations of K & L (from production function) that will give Q
• Plot

Question 40

What is the cost min bundle?

Answer 40

• Cost min bundle: w/v = MRTS (= MPL/MPK = K/L)

Question 41

With one input fixed and output given what are the steps to cost min?

Answer 41

1. Input costs into cost min bundle: w/v = K/L
2. From this determine RATIO of K to L at cost min
3. Plug this proportion into production function
4. Determine K and L from doing this
   (5. Plug this into TC equation and answer = isocost)
   (6. Determine isocost intercepts)

Question 42

What is the difference between RTS and EoS?

Answer 42

RTS - Production

EoS - Cost Structure

Question 43

What is true of the isoquant when w/v changes in cost min?

Answer 43

Isoquant must shift (change output) if w/v changes and one input is fixed