Costs of production Flashcards
What is the difference between fixed and variable costs?
Fixed Costs: Expenses that remain constant regardless of the level of output produced. Examples include rent, salaries of permanent staff, and insurance premiums
Variable Costs: Costs that change directly with the level of production. Examples include raw materials, direct labor, and utilities used in production
Example: A factory’s monthly rent is a fixed cost, while the cost of raw materials used in production is a variable cost.
What is the difference between marginal, average, and total costs?
1)Total Cost (TC): The sum of fixed and variable costs at a given level of output.
2)Average Total Cost (ATC): Total cost divided by the quantity of output produced (ATC = TC/Q)
3)Marginal Cost (MC): The additional cost incurred from producing one more unit of output. It is calculated as the change in total cost divided by the change in quantity (MC = ΔTC/ΔQ)
Example: If producing 100 units costs £500 and producing 101 units costs £505, the marginal cost of the 101st unit is £5.
What are the reasons for the shape of the marginal, average, and total cost curves?
1)Total Cost Curve: Initially increases at a decreasing rate due to increasing marginal returns, then at an increasing rate due to diminishing marginal returns
2)Average Total Cost Curve: U-shaped; declines initially due to economies of scale, reaches a minimum point, then rises due to diseconomies of scale
3)Marginal Cost Curve: U-shaped; initially decreases as production becomes more efficient, then increases due to diminishing marginal returns
Example: In a factory, adding more workers initially increases output efficiently (decreasing marginal cost), but after a certain point, overcrowding leads to inefficiencies (increasing marginal cost).
What is the difference between short-run and long-run costs?
1)Short-Run Costs: Costs incurred when at least one factor of production is fixed. In the short run, firms can vary some inputs (like labor) but not others (like capital).
2)Long-Run Costs: Costs incurred when all factors of production are variable. In the long run, firms can adjust all inputs, including capital, to optimize production.
Example: In the short run, a bakery can hire more staff to increase output but cannot expand its premises. In the long run, the bakery can build a larger facility and hire more staff.
How do factor prices and productivity affect firms’ costs of production and their choice of factor inputs?
1)Factor Prices: Higher prices for factors of production (e.g., wages, raw materials) increase variable costs, leading firms to seek cost-effective inputs or alternative production methods
2)Productivity: Higher productivity reduces the amount of input needed for a given level of output, effectively lowering costs
Example: If the price of steel rises, a car manufacturer may seek alternative materials or more efficient production techniques to maintain profitability. Conversely, if workers become more skilled, the company can produce more cars with the same amount of labor, reducing labor costs per unit.
