quiz 2 - production costs, profit maximization

Question 1

what three considerations must firms make?

Answer 1

1 - what is the lowest cost method of producing good
2 - given the costs for producing each possible good, what should they produce
3 - how much of that good should they produce?

Question 2

what are the three types of costs

Answer 2

accounting costs

economic costs

opportunity costs

Question 3

accounting cost

Answer 3

Actual expenses plus depreciation charges for capital equipment

Question 4

economic costs

Answer 4

Cost to a firm of utilizing economic resources in production, including opportunity cost

Question 5

opportunity costs

Answer 5

Cost associated with opportunities that are forgone when a firm’s resources are not put to their best alternative use.

Question 6

total costs

Answer 6

Total economic cost of production, consisting of fixed + variable costs

Question 7

fixed costs

Answer 7

Cost that does not vary with the level of output and that can be eliminated only by shutting down

Examples include overhead costs like paying the electricity bill in an office, or paying back office staff like accountants

In the long-run, no costs are fixed because if production increased enough, you would need more offices and more accountants

A fixed cost can be avoided in the long run (but not in the short run) – you can shut down your operation and stop paying the cost

Question 8

variable cost

Answer 8

aka marginal costs

Cost that varies as output varies.

variable cost = sum of all marginal costs

Question 9

sunk cost

Answer 9

Cost that has already been incurred and cannot be recovered (even if you shut down)

Question 10

is a warehouse a sunk cost?

Answer 10

no, if you have a warehouse, it is a fixed cost. However, it is not sunk, because you can sell the warehouse – it has an alternative use

Question 11

is a market study a sunk cost?

Answer 11

yes, it is a fixed cost, but it is also sunk because you cannot sell it – it has no alternative use

Question 12

is tuition a sunk cost

Answer 12

yes

Question 13

how do costs change over time

Answer 13

in the very short run, all costs are fixed

in the very long run, all costs are variable

Question 14

average total cost

Answer 14

firm’s total cost divided by output

AC(Q) = C(Q)/Q

note that total cost includes fixed and variable costs

Question 15

marginal cost

Answer 15

Increase in cost resulting from the production of one extra unit of output.

MC = dTC/dQ

Question 16

what is the relationship between MC and AC

Answer 16

If MCAC, AC is increasing

MC=AC at minimum AC

Question 17

what is the relationship between MC and supply curve

Answer 17

they’re the same

Question 18

total variable cost

Answer 18

is often just called variable cost

Question 19

describe shape of marginal cost curve

Answer 19

marginal cost initially declines, then increases

why do they decrease? 2 reasons:

1 - The initial decrease is caused by improvements in productivity from specialization. At low levels of output, inputs (labor) cannot specialize. As more output is made, more inputs are hired and they can specialize.

2 - fixed costs per unit become smaller as more units are produced

why do they later increase? because of decreasing marginal gains = firm becomes bigger, costs become greater because inputs become scarce

Question 20

where do MC and ATC intersect?

Answer 20

at the minimum of the ATC curve

the same relationship holds for average variable cost curve (MC intersects AVC at AVC’s minimum)

Question 21

describe shape of average fixed cost curve

Answer 21

always declining - as you make more units, the fixed costs are spread over a greater number of units; since fixed costs don’t change and Q is increasing, average fixed cost is decreasing

Question 22

economies of scale

Answer 22

as Q increases, ATC decreases; this is because larger scale allows specialization, optimized use of inputs and buying power to negotiate prices

but at some point, Q increases enough that ATC starts to increase; this is because very large firms become more complex and harder to manage; they have exhausted their efficient inputs and have to rely on increasingly inefficient ones that drive costs up; you get diminishing returns to your inputs (called diseconomies of scale)

Question 23

what does it mean if a firm has a total cost curve that is declining

Answer 23

this means that each unit of output produced drives costs down indefinitely; this is only possible if the firm has very high fixed costs relative to marginal costs

this is a natural monopoly - most efficient outcome is if this one firm produces all of the output

good example of natural monopolies is a utility company - extremely high fixed costs (the power line distribution) but running electricity through those lines has very low marginal cost

Question 24

what is the slope of a firm’s production possibilities frontier?

Answer 24

its marginal cost

Question 25

supply is based on ____

profit is based on _____

Answer 25

marginal cost

average cost