Costs And Their Relationship To Output Size Short Run and Long Run Considerations.

Question 1

What are Explicit Costs?

Answer 1

• An explicit cost has been incurred when cash expenditures are made. Eg: fertiliser, feed, etc.
• It is estimated that explicit costs only account for about one third of the total costs on a farm.

Question 2

What is an Implicit Cost?

Answer 2

• An implicit cost has been incurred when there has been no cash outlays for the use of a resource. Eg: the owners labour if they were employed elsewhere.
• Although they do not have a direct cost, they have an opportunity cost or an implicit cost.
• If implicit costs are not considered the profits and losses of a business may not be correctly quantified.

Question 3

What is meant by Depreciation?

Answer 3

• Depreciation is the erosion in value of capital equipment over time. Depreciation has both explicit and implicit costs.
• In accounting it is an explicit cost, but not a cash cost unless funds are set aside.
• Depreciation, as an implicit cost, should represent the ‘true cost’ of using capital items. Therefore, in economic profit depreciation is best treated as an implicit cost.

Question 4

What is Accounting Profit?

Answer 4

Accounting profit = total revenue - explicit costs

Question 5

What is Economic Profit?

Answer 5

Economic profit = total revenue - explicit costs - implicit costs

Question 6

What are Fixed Costs?

Answer 6

Fixed costs - the costs that do not vary with level of production. There are no fixed costs in the long run. Eg: land rent, rate, insurance, etc.

Question 7

What are variable Costs?

Answer 7

Variable costs - the costs that vary with the level of production. Applicable to both short- and long run. Eg: feed, fertilizer, chemicals, fuel, etc.

Question 8

What is a Length Of Run?

Answer 8

Length of run is a planning concept relating to the proportion of a farm’s inputs that are fixed, or varied, for a given time period.
Therefore long run is a time period, as long as everything is variable. But for a short run, at least one input is fixed and the others can be variable.

Question 9

What is a Marginal cost?

Answer 9

Marginal Cost (MC) - an increase in the cost as the output increases by one unit (different from MFC).
MC decline initially, and reach a minimum, and then rises (for the underlying reason of implication of the Marginal Physical Productivity of the inputs).

Question 10

What is Long Run?

Answer 10

• Long run is a period of time sufficient for the firm to alter all factors (inputs) of production.
• Long run differs by industry (here many firms producing the same product is referred as an industry). And that firms can enter and exit the industry.
• Long-run ATC shows the minimum average cost of producing each level of output, when a firm is able to vary its all production resources including factory size.

Question 11

What is Terms Of Trade?

Answer 11

Terms of trade = EPI / IPI
(EPI = Export Price Index; IMP = Import Price Index)
Farmers terms of trade = The ratio of prices received by farmers to the prices paid by the farmers as indexed by the ABARE.

Question 12

What are some Strategies To Reduce Costs?

Answer 12

• Input substitution - changing to a cheaper replacement
• Substitution of explicit cost inputs by implicit cost inputs - reduces cash flow requirements but does not remove the costs. Often associated with a loss in productivity.
• Defer expenditure - for payment of some fixed costs, eg. fencing repairs.
• Increase productivity - additional costs should pass the marginal cost-marginal return test (MR > MC).
• Productivity can be reduced by lower average costs over a greater volume of output.
• Increase size/scale of enterprise - new investment, cost reduction should be a long-term business plan

Question 13

Key Terms

Answer 13

•Resources and their implicit and explicit costs •Accounting profit > Economic profit
•Fixed and variable costs (depends on length of run) •Total costs = Fixed costs + Variable costs
•Average Total Costs (ATC) (economies of scale) •ATC = Av. Var. Costs (AVC) + Av. Fix. Costs (AFC) •Marginal Cost (MC) and firm’s supply curve
•Total Revenue (TR) = Quantity produced x Price •Average Revenue (AR) and Marginal Revenue (MR)
•When MPP increases MC decreases
(due to increasing rate of return for the input)
•AVC is the reciprocal of the APP curve •Break-even level of output (TR = TC)
•Profit maximising level of output (MR = MC) •Long run ATC
•Economies of scale •Economics of size
•Costs relationship in farming (trends in costs and return - ABARES farm survey data)
•Farmer’s terms of trade
•Strategies to reduce costs (examples!)