Production And Its Costs (Topic 6)

Question 1

2 time frames

Answer 1

1) short run : a period of time so short that there is at least one fixed input

2) long run : a period of time so long that all inputs are variable (no fixed input)

Question 2

2 types of input

Answer 2

1) variable input : input whose quantity can be changed during the period of time under consideration (workers)

2) fixed input : input whose quantity cannot be changed during the period of time under consideration (factory size)

Question 3

1st product curve in SR

Answer 3

Total product curve shows the output that is produced when additional units of VI (Workers) are added to the FI (tractor)

Question 4

Shape of TP curve

Answer 4

SR TP curve is affected by the Law of Diminishing returns which states that beyond some point the MP decreases as additional units of a variable factor are added to a fixed factor

Draw

Question 5

2nd product curve in SR

Answer 5

Marginal product measures the change in total output resulting from the addition of an extra unit of variable input

MP = △TP / △VI

Question 6

Why does MP increase or decrease?

Answer 6

MP increases due to better combination of VI and FI and better usage of the FI

MP decreases as the combination of VI to FI is no longer optimal

(As long as output is increasing, MP is still positive)

For output to fall, MP must be negative. There are now too many VI and too little FI to work with. Each subsequent VI reduces the output produced.

Question 7

Relationship between MP and TP curve

Answer 7

Draw

Question 8

3rd product curve in SR

Answer 8

Average product is the total output divided by the number of VI used

AP = TP / VI

Question 9

Relationship between MP and AP curve

Answer 9

Draw

Question 10

1st SR total cost curve, shape

Answer 10

Total Fixed Costs (TFC)

Costs of the firm’s fixed inputs, costs that do not vary as output caries and must be paid even if output is zero

hence TFC is a horizontal line

Question 11

2nd SR total cost curve

Answer 11

Total Variable Costs (TVC)

Costs of the firm’s variable inputs, costs that are zero when output is zero and vary as output varies

Draw

Question 12

3rd SR total cost curve

Answer 12

The sum of total fixed cost and total variable cost at each level of output

TC = TFC + TVC

At zero out put TC = TFC since TVC is zero

Draw all 3 together

Question 13

1st SR average cost curve

Answer 13

Average Fixed cost (AFC)

Fixed cost per unit of output

AFC = TFC / Q

AFC ↓ as output ↑ → The given amount of fixed cost is spread over a bigger output

Draw

Question 14

2nd SR average cost curve

Answer 14

Average Variable Cost (AVC)

Variable cost per unit of output

AVC = TVC / Q

Draw

Question 15

3rd SR average cost curve

Answer 15

Average Total Cost (ATC)

Total cost per unit of output

ATC = TC / Q

ATC = AFC + AVC

The U-shape of the ATC curve is because of the shape of the AFC and AVC combined

The distance between the ATC and AVC is the AFC

AFC = ATC - AVC

Draw

Question 16

Relationship between ATC and AVC

Answer 16

1) ATC is always greater than AVC

2) Gap between ATC and AVC = AFC

3) Gap between ATC and AVC gets smaller as output increases (AFC falls as output increases)

Question 17

4th SR average cost curve

Answer 17

Marginal Cost (MC)

The change in total cost when one additional unit of output is produced

MC = △TC / △Q or △TVC / △Q

Draw

Question 18

Shape of MC?

Answer 18

MC curve is U shaped

MC decreases as output increases because of better combination of variable input and fixed input

But as output increases, MC increases because of the law of diminishing returns

Question 19

Relationship of MC, AVC and ATC

Answer 19

1) MC < AVC or ATC, AVC and ATC will ↓

2) MC > AVC or ATC, AVC and ATC will ↑

3) MC must = AVC and ATC at their respective minimums

Draw

Question 20

Best input combination

Answer 20

The best input combination is the one that enables the firm to produce its output at the lowest cost

Question 21

Relationship between MC and AFC

Answer 21

MC is not related to AFC. MC is a variable cost while AFC is a fixed cost.

Question 22

Long run (1)

Answer 22

Increasing returns to scale / economies of scale

Occurs when a firm’s output increases more than proportionately to the increase in all its inputs

Double all inputs → output more than doubles

Why? As a firm initially expands, its resources are able to better specialised or concentrate on doing what they are best at

Draw

Question 23

Long run (2)

Answer 23

Decreasing returns to scale / diseconomies of scale

Output increases less than proportionately to the increase in all its inputs

Double all inputs → output less than double

Why? When a firm becomes too big, red tapes and management problems arises

Draw

Question 24

Long run (3)

Answer 24

Constant returns to scale

Output increases proportionately with the increase in all inputs

Double all inputs → outputs also doubles

Why? Productivity does not change therefore average cost will be constant