Topic 3 - Supply and Production Costs

Question 1

What is the short run?

Answer 1

Time frame in which the quantity of at least one factor of production is fixed. It’s usually capital, land and entrepreneurship which are fixed - production and labour are variable factors. The fixed factors are called the plant.

Question 2

What is the long run?

Answer 2

Time frame in which the quantities of all factors of production can be varied. The only costs that influence its current decisions are the short-run cost of changing its labour inputs and the long run costs of changing the plant.

Question 3

What is a sunk cost?

Answer 3

The past expenditure on a plant that has no resale value.

Question 4

What is total product?

Answer 4

The maximum output that a given quantity of labour can produce.

Question 5

What is the marginal product of labour?

Answer 5

The increase in total product that results from a one-unit increase in the quantity of labour employed.

Question 6

What is the average product of labour?

Answer 6

Is equal to the total product divided by the quantity of labour employed.

Question 7

Why are the shapes of product curves similar?

Answer 7

1 = Increasing Marginal Returns initially
2 = Diminishing Marginal Returns eventually

Question 8

What are increasing marginal returns?

Answer 8

It occurs when the marginal product of an additional worker exceeds the marginal product of the previous worker. It arises from increased specialisation and division of labour in the production process.

Question 9

What are diminishing marginal returns?

Answer 9

Occurs when the marginal product of an additional worker is less than the marginal product of the previous worker. It happens because more and more workers are using the same capital and working in the same space.

Question 10

What is total cost?

Answer 10

The total cost of all the factors of production a firm uses.

Question 11

What is total fixed cost?

Answer 11

Cost of a firm’s fixed factors, eg, the cost of renting equipment.

Question 12

What is total variable cost?

Answer 12

Cost of variable factors, such as labour.

Question 13

What is marginal cost?

Answer 13

The increase in total cost that results from a one-unit increase in output.
MC = Increase in TC/Increase in ouput

Question 14

What happens to marginal cost?

Answer 14

At small outputs, marginal cost decreases as output increases because of greater specialisation and the division of labour. However, as it increases further, mc eventually increases due to the law of diminishing returns.

Question 15

Where does the MC curve cross the AVC and ATC curves?

Answer 15

At their minimum points.

Question 16

Why is the ATC curve u shaped?

Answer 16

It’s the sum of AFC and AVC curves, so it arises from spreading the total fixed cost over a larger output and the eventually diminishing returns. When output increases, firms spread their TFC over a larger output so its AFC decreases and it slopes downwards. However as output increases, more labour is needed to produced one more unit so AVC increases and the curve slopes back up again.

Question 17

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

Answer 17

1 = Technology
2 = Prices of factors of production

Question 18

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

Answer 18

A tech. change that increases productivity increases the marginal product and average product of labour. With better tech. the same factors of production can produce more output. This means that the costs of production are lowered and the cost curves shift downwards.

Question 19

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

Answer 19

Increasing price of a factor of production increases the firms costs and shifts its cost curves.
Increase in a fixed cost shifts TFC, AFC and TC curves upwards but leaves AVC, TVC + MC curves unchanged.
Increase in a variable cost shifts TVC, AVC and MC curves upwards but leaves AFC and TFC unchanged.

Question 20

What is the production function?

Answer 20

The relationship between max output attainable and the quantities of labour and capital.
Y = F(L,K)
Y = Output
L = Labour (variable factor of production)
K = Capital (fixed factor of production)

Question 21

What is the marginal product of capital?

Answer 21

The change in total product divided by the change in capital, when labour is constant.

Question 22

How do larger plants affect ATC curves?

Answer 22

The minimum average total cost for a larger plant occurs at a greater ouput, because it has a higher TFC so a higher AFC.

Question 23

What is the long-run average cost curve?

Answer 23

The relationship between the lowest attainable ATC and output, when the firm can change the plant it use and the quantity of labour it employs.

Question 24

What are economies of scale?

Answer 24

Features of a firms technology that make ATC fall as output increases, greater specialisation of labour and capital and the main sources of this.

Question 25

What are diseconomies of scale?

Answer 25

Features of a firms technology that make ATC rise as output increases, when these are present the LRAC curve slopes upwards.

Question 26

What are constant returns to scale?

Answer 26

Features of a firms technology that keep ATC constant as output increases. This is when the LRAC is horizontal.

Question 27

What is a minimum efficient scale?

Answer 27

The smallest output at which long-run average cost reaches its lowest level.

Question 28

What is the average cost?

Answer 28

Cost per unit of output.

Question 29

Why is the long run cost curve flatter than the short run curve?

Answer 29

The firm can increase output by increasing capital rather than hiring another worker.

Question 30

What shape is the supply curve?

Answer 30

The higher the price of a good, the greater is the quantity supplied. So the supply curve is upwards sloping.

Question 31

What is supply and quantity supplied?

Answer 31

Supply = entire relationship between the price of a good and the quantity supplied of a good.
Quantity Supplied = the amount supplied at a given price.

Question 32

What happens when supply increases?

Answer 32

The supply curve shifts to the right.