Output and Costs 2.0

Question 1

Why is the ATC curve u shaped?

Answer 1

ATC is the sum of AFC and AVC. The shape of the ATC curve combines the shapes of AVC and AFC. The u shape arises due to two opposing forces:

• Spreading total fixed cost over a larger output
• Eventually diminishing returns

Question 2

What affect does the spreading of fixed costs have on the ATC curve?

Answer 2

As fixed costs are spread, average fixed cost falls causing the curve to slope downward

Question 3

What affect does diminishing returns have on the ATC curve?

Answer 3

As output increases, more labour is needed to produce an additional unit so AVC eventually increases and the AVC curve slopes upward

Question 4

How does the ATC curve combine the effects of diminishing returns and the spreading of fixed costs?

Answer 4

Initially, both AFC and AVC decrease do the ATC slopes downward. As output increases further, and diminishing returns set in, AVC increases. AVC eventually increases at a faster rate than AFC falls causing the ATC to slope upward

Question 5

What is the link between total product and total cost curves?

Answer 5

TP = TVC, output plotted against labour is TP and output plotted against the cost of labour is TVC, the graph can show labour and cost on the x axis because variable cost is proportionate to labour

Question 6

What is the relationship between average product and marginal product and average cost and marginal cost?

Answer 6

As marginal product and average product rise, marginal cost and average variable cost fall. At the point of average maximum product, AVC is at a minimum. As labour increases further, AP decreases and AVC increases.

Question 7

What does the position of a firm’s short run cost curve depend on?

Answer 7

• Technology

- Prices of factors of production

Question 8

How does technology affect the position of a firm’s short run cost curves?

Answer 8

A technological change that increases productivity and thus MP and AP lowers the
cost of production and shifts the curve downward because the same FOPs are producing more output.

Question 9

How does technology affect small and large outputs?

Answer 9

The change in the mix of fixed costs and variable cost means that at small outputs, ATC might increase, while at large outputs, ATC decreases.

Question 10

How do the prices of factors of productions affect the position of a firm’s short run cost curve?

Answer 10

An increase in the price of an FOP increases the firm’s costs and shifts its cost curves. How the curves shift depends on which factor price changes.

Question 11

What impact does a shift in rent or a fixed FOP have on the short run cost curve?

Answer 11

It shifts the TFC and AFC curves upward and shifts the TC curve upward but leaves the AVC and TVC and MC unchanged.

Question 12

What impact does a shift in wages or a variable FOP have on the short run cost curve?

Answer 12

It shifts the TVC and AVC upward and shifts the MC upward but leaves the AFC and TFC unchanged.

Question 13

What is the nature of costs in the long run?

Answer 13

All costs are variable as a firm can change both the quantity of labour and the quantity of capital, the behaviour of these costs depends on the firm’s production function

Question 14

What is the firm’s production function?

Answer 14

The relationship between the maximum output attainable and the quantities of both labour and capital,

Question 15

How are diminishing returns present in the firm’s production function?

Answer 15

They occur as the quantity of labour increases because the marginal product of labour eventually decreases

Question 16

What is diminishing marginal product of capital?

Answer 16

The marginal product of capital is the change in total product divided by the change in output when the quantity of labour is constant.

Question 17

How does the minimum ATC vary between small and large plants?

Answer 17

It occurs at a greater output for larger plants than it does for smaller plants because the larger the plant, the higher total fixed cost and therefore, for any given output, a higher average fixed cost

Question 18

Which size plant is the economically efficient plant for producing at a given output?

Answer 18

The one that has the lowest ATC, when a firm is producing a given output at the least possible cost, it is operating on its long run average cost curve

Question 19

What is the long run average cost curve?

Answer 19

The relationship between the lowest attainable average cost and output when the firm can change both the plant it uses and the quantity of labour it employs

Question 20

How does the LRAC curve help a firm plan?

Answer 20

It tells the firm the plant and the quantity of labour to use at each output to minimise average cost. Once the firm chooses a plant, the firm operates on the short run cost curves that apply to that plant.

Question 21

When do economies of scale occur along the LRAC curve?

Answer 21

If average cost falls as output increases

Question 22

When do diseconomies of scale occur along the LRAC curve?

Answer 22

If average cost rises as output increases

Question 23

What are economies of scale?

Answer 23

Features of a firm’s technology that make average total cost fall as output increases, causes LRAC curve to slope downward

Question 24

What are diseconomies of scale?

Answer 24

Features of a firm’s technology that make ATC rise as output increases, causes LRAC curve to slope upward

Question 25

What is the minimum efficient scale?

Answer 25

The smallest output at which LRAC reaches its lowest level, it is found where average cost is lowest