Economics Review-Costs of production

Question 1

What is fixed cost?

Answer 1

The cost that doesn’t change as output changes

Question 2

What is variable cost?

Answer 2

The cost that changes as output changes

Question 3

What is total cost?

Answer 3

It is the total minimal cost that needs to be paid by the firm to produce an output. So VC+ FC=TC

Question 4

What does the total cost curve look like?

Answer 4

It is Up-ward sloping

Question 5

Why is the total cost curve upward sloping?

Answer 5

Since fixed cost stays fixed, there will be a gap between the x-axis and the curve. It is upward sloping since variable cost is subject to change as output increases, or decreases.

Question 6

What is average cost?

Answer 6

It is sometimes called average cost per unit which is found by TC/Q.

Question 7

What does the average cost curve look like?

Answer 7

It is U shaped

Question 8

Why is the average cost curve U-shaped?

Answer 8

It is U shaped because of fixed cost. In the beginning if a small amount of output is produced, then it is hard to share the fixed cost among the revenue firms get from the output. As output increases, the fixed cost amount is easily divided among the output sold and therefore decreases. If output is increased anymore however, then scarce resources may become a problem, where producing more output requires more effort and thus more costs.

Question 9

What is marginal cost?

Answer 9

• The extra cost of producing one extra unit

- The increase in Total Cost from producing one more unit

Question 10

If the marginal cost is the extra cost of producing one extra unit, How do you find the MC?

Answer 10

On a chart, at quantity 0, indicates what the fixed cost is. Once you know that, take the known total cost and subtract it by the fixed cost. You will get your vairbale cost(just in case you need this)

But if you really want to find marginal cost, simply take the change in total cost and divide by the change in quantity. Change in Total Cost/Change in Q=MC

Question 11

What does the marginal cost curve look like?

Answer 11

It increases just like the total cost curve, except more flatter.
The marginal cost(“extra cost” of producing one extra unit of output) increases because it is more costly to produce one extra unit. Perhaps, a worker needs to work extra hours to create the product or more workers need to be hired(the factors of production become scarcer and therefore need to be increased.)

Question 12

What is the production function?

Answer 12

The production function depicts the relationship between
the quantity of input used to produce the good and the quantity of output, of that good.

Think of farmer jack. The y-axis is the quantity of output, which is dependant on the x-axis, or the no. of workers. As workers increase, Q of output also increases. However, as there are too many workers, the quantity of output starts to decrease(since there might not be enough resources for the workers to work with)

Question 13

Implicit vs. Explicit costs

Answer 13

Implicit-accounts for the opportunity cost of firms(money is not given out to others, it is more of a theoretical cost)

Explicit costs-on the other hand, are the costs which firms must pay others for their costs of production ex.fixed and variable costs.

Question 14

Accounting vs. Economic profit

Answer 14

Accounting profit-only accounts for the the explicit costs. So TR - TC(which is also FC+VC).

Economic profit- on the other hand, includes both implicit and explicit costs: TR - TC(implicit + explicit(FC+VC)))

Question 15

What is marginal product?

What is the marginal product of labour?

Answer 15

Essentially a trick question:

the marginal product of any input is:
the increase in output that occurs when you add one more unit of that input, holding all other inputs constant.

So when farmer Jack hires an extra worker, his costs rise by the MPL(or the wage he pays the worker). His output also rises by the MPL

-So if we were to calculate the number of workers who input their labour, we would not include the increase of raw materials.

Question 16

What is the formula for MPL(Marginal product of Labour)?

Answer 16

change in Q/ change in L or labour(# of workers)

Question 17

What is the simplest and key thing to think about to understanding the decision a firm makes about how many workers to hire and how much output to produce? (from chapter 1)

Answer 17

Rational people think at the margin.

Question 18

Back to MPL(Marginal product of labour), why does it diminish?

Answer 18

MPL due to resource scarcity. As a firm increases their quantity of input, say the workers, then the workers have less to work with. Ex. If farmer Jack hired more workers, he would be short of other factors of production such as tractors, farm animals etc and vice versa as well.

Question 19

How does MPL diminish?

Answer 19

MPL diminishes as labour increases, whether the land or capital(equipment, machines, etc).

Question 20

Diminishing marginal product?

Answer 20

The marginal product of input falls as the quantity of input rises.

• A diminishing marginal product is a very steep total cost curve
  - if you think about it, the x axis is the quantity of output while the y-axis is the costs of producing at each output. The steep curve represents how the cost increases more significantly than the quantity produced. Which explains why increasing input(in this case, costs to make the good)does not increase output at the same rate.

while increasing one input and keeping other inputs constant may initially increase output, further increases in that input will have a limited effect, and eventually no effect or a negative effect, on output. The law of diminishing marginal productivity helps explain why increasing production is not always the best way to increase profitability.

let’s consider a pizza restaurant that wants to increase profitability. Increasing the amount of cheese (the input) that goes on each pizza can create a more delicious product and sell more pizzas. But at some point, the pizza reaches an optimal cheese level. The amount of cheese must be balanced with the crust thickness, amount of sauce and other pizza toppings, if any. If the restaurant continues to add more cheese to the pizza beyond the optimal level, its sales will decline because customers will not enjoy pizzas that leave them with a mouthful of cheese and little else.

So think of marginal product as the whole good while input being one singular part that makes the good. Ex. To create a computer, you need workers. Increasing workers increases profit. You only increase workers and nothing else lets say. As you increase workers, the marginal product of input starts to fall(since there are more workers than there are computers). So workers are the input while computers are the marginal product of input that falls.

Question 21

Remember that rational people think at the margin. If this is the case, then come up with two scenarios where Farmer Jack would increase/decrease production.

Answer 21

Jack like any sensible person, wants to get as much profit as he can. So if MC is less than revenue, Jack will produce more of his good.

If MC is greater than revenue, Jack will produce less of his good.

Question 22

What does an average fixed cost curve look like?

Hint: Use some logic-as in what happens to fixed cost as you increase quantity of output

Answer 22

The average fixed cost curve starts out very high, but begins to decrease. Here you also have to think about the equation of how to get AFC: FC/Q

This is due to the dispersion of the fixed cost after output increases. Remember that fixed cost doesn’t change as output changes. It stays the same. Ex. fixed cost of land is $100. So as output increases, each unit of output takes on a portion of the fixed cost, which makes paying for fixed cost easier.

Question 23

Using logic as well, what does the average variable cost curve take the shape of?

Answer 23

It is U-shaped, just like average cost since if you increase more workers, their production is less efficient(materials needed to create goods is more scarce)

Question 24

How do you calculate average total cost?

Answer 24

ATC= TC/Q or ATC= AFC + AVG

Question 25

What is the shape of an average total cost curve?

Answer 25

It is more moon shaped. The curve starts at a very high price and begins to decrease as quantity increases. However, is does slowly increase, but not to the extent of the average cost curve.

Question 26

Why is ATC usually U/moon shaped?

Answer 26

Initially, the falling AFC pulls ATC down. Eventually the rising AVC pulls ATC back up

Question 27

The efficient scale?

Answer 27

Efficient scale-the quantity that minimizes ATC. This is important in the analysis of competitive firms

Question 28

When MC<ATC,

Answer 28

ATC is falling.

When marginal cost is less than ATC, think of it in the way that there is less of a cost(since the output is decreased by one). So this would also full ATC down. MC is kind of related to Variable cost, which is part of the ATC equation.

Question 29

When MC>ATC,

Answer 29

ATC is rising. Think of it like this: When marginal cost is greater, it means there is an extra cost to producing one additional unit of the good. So naturally ATC will be “pulled up” by the MC. and vice versa.

Question 30

Short-run costs vs. Long-run costs

Answer 30

Short-run: Some inputs are fixed. The cost of these inputs are fixed costs. ex. factory, land etc.

Long-run: All inputs are variable (ex. firms can build more factories or sell existing ones

In the long run, ATC at any Q is cost per unit using the most efficient mix of inputs for that quantity. (ex. factory size with the lowest ATC)

Question 31

What are the three important points to remember about the cost curves?

Answer 31

1. MC eventually rises with the quantity of output
2. The ATC curve is U-Shaped(and you should know why by now)
3. The MC curve crosses ATC at the minimum of the ATC curve.

Question 32

How do the short-run and long-run average total cost curves relate?

Answer 32

The LRATC curve is a long, u-shaped one. The short-run average total cost curve either lies above or touches the long run cost curve. Additionally, there are many short-run cost curves(ex. small, medium and large factory)

These properties arise because firms have a greater flexibility in the long run. In essence, the firm in the long run gets to choose which short run curve it wants to use. However in the short run, it has to use whichever curve it chose in the past. (Ex. 妈咪 and 爸爸 choosing a house to rent to people. They have a variety of choices( a old house, fancy house, or modern house. However once they choose their “factory”, they must stick to the one they chose in the past.))

Question 33

In the LRATC curve, there are three sections to it. Name them fool:

Answer 33

Economies of scale (located on the very left of the LRATC curve): ATC falls as Q increases

Constant returns to scale(located at the middle of the curve): ATC stays the same as Q increases

Diseconomies of scale(located on the very right of the curve): ATC rises at Q increases

Question 34

Based on your previous answer, what causes economies of scale in LRATC?

What causes diseconomies of scale in LRATC?

Answer 34

Economies of scale occur when increasing production allows for greater specialization; workers become more efficient with specific tasks.

Diseconomies of scale occur due to poor management in large organizations. (ex. Management becomes stretched(too many workers), can’t control costs)