Costs of Production - Short Run

Question 1

What are explicit costs?

Answer 1

Explicit costs are costs involving the payment of money made by a firm to obtain a factor of production.

Example: Wages paid to workers

Question 2

What are implicit costs?

Answer 2

Implicit costs are costs involving sacrificed income for the use of a factor of production that is owned by the firm.

Example: Rental income sacrificed for using a self-owned building

Question 3

What are economic costs?

Answer 3

The sum of explicit and implicit costs

Question 4

What is the relation between costs of production and opportunity costs?

Answer 4

All costs of production are opportunity costs. In the case of explicit costs, opportunity costs are the value of the best alternative that was not purchased. In the case of implicit costs, opportunity costs are the sacrificed income.

Question 5

What are total fixed costs (TFC)?

Answer 5

Fixed costs are those that do not vary with output. They arise from the use of fixed factors of production.

Example: Rental payments, payment of insurance

Question 6

What are total variable costs (TVC)?

Answer 6

Variable costs are those that vary with output. They arise from the use of variable inputs.

Example: Wage cost of labor, raw material costs

Question 7

What are total costs (TC)?

Answer 7

Total costs are the sum of fixed and variable costs.

Question 8

What are average costs?

Answer 8

Average costs are costs per unit of output.

They tell us how much each unit of output produced costs on average.

Question 9

What are marginal costs?

Answer 9

Marginal cost is the extra or additional cost of producing one more unit of output.

It tells us by how much total costs increase if there is an increase in output by one unit.

Marginal cost = change in total cost / change in
quantity

Question 10

What is the relationship between MC and AVC curves to MP and AP curves?

Answer 10

1. MC is a mirror image of MP
2. When MC is decreasing, MP is increasing
   
   • This is because if the extra output produced by
     each additional unit of labor is increasing, the
     additional cost of that additional unit is decreasing
3. When MP is at its maximum, MC is at its minimum
   
   • When the additional output produced by an extra
     worker is the most it can be, then the extra labor
     cost of producing an additional unit of output is the
     least it can be
4. AVC is a mirror image of AP
5. When AP is increasing, AVC is decreasing
   
   • This is because when AP is increasing, each
     additional unit of output can be produced with
     fewer and fewer units of labor; therefore, the cost
     of each unit of output falls
6. When AP is decreasing, AVC is increasing
   
   • When AP is decreasing, additional units of output
     require more and more units of labor; therefore,
     the labor costs of each unit of output increases