Unit 7: the cost of production

Question 1

what is economic costs?

Answer 1

these refers for implicit and explicit costs ( accounting expenses)

Question 2

what are accounting costs?

Answer 2

these refers to explicit costs only

Question 3

what are sunk costs?

Answer 3

these refers to costs that have been incurred by and cannot be recovered

Question 4

what are fixed costs (FC)

Answer 4

these refers to costs that don’t depend on output

Question 5

what are variable costs? (VC)

Answer 5

these refers to the costs that depend on output

Question 6

what are total costs? (TC) and what is the formula for TC?

Answer 6

this refers to the sum of fixed costs. TC= FC + VC

Question 7

what are average variable costs? what is the formula?

Answer 7

these refers to the variable costs per unit output. AVC= VC/Q

Question 8

what is average total costs? and what is the formula?

Answer 8

this refers to the total costs per unit of output. ATC= TC/Q

Question 9

what is the margins cost and what is the formula?

Answer 9

this refers to the additional unit incurred for producing the additional unit of output. change in total costs (TC)/change in quantity (Q) = change in variable cost (VC)/change of quantity (Q)

Question 10

how do we know that a cost is fixed?

Answer 10

they’re costs over a short period of time.

Question 11

how do we know that a cost is a variable cost?

Answer 11

a cost over a longer period of time

Question 12

what is short-run in terms of the factors of production and input?

Answer 12

it is a period which at least one factor of production/input is fixed

Question 13

what is long-run in terms of the factors of production/inputs?

Answer 13

it is a period which all factors of production/inputs change

Question 14

what are the diminishing marginal returns and marginal cost?

Answer 14

the marginal product of labour decreases as the quantity of labour employed increases

Question 15

what is the formula for Marginal costs in terms of the variable costs being the per-unit cost of the extra labour to times the amount of extra labour needed to reduce the output?

Answer 15

MC= change in variable cost/change in quantity = wages timed change in labour/ change in quantity

Question 16

in short-run curves, what is the relationship between marginal ( MC) and average cost curves? ( 3 points)

Answer 16

1. when MC< ATC, then ATC decreases
2. when MC > ATC, then ATC increases
3. ATC at minimum, then MC= ATC. Normal profit earned and point of efficiency

Question 17

in short-run curves, what is the relationship between average cost (ATC), average variable cost ( AVC) and average fixed cost ( AFC) ?

Answer 17

ATC= AVC + AFC

Distance between ATC and AVC decreases as AFC decreases and output increases

Question 18

what is the user cost of capital and what is the formula for it?

Answer 18

the user cost of capital is the annual cost of owning and using the asset instead of selling it or never buying it in the first place. Formula :

user cost of capital = economic depreciation + (interest rate) ( value of capital)

Question 19

how can we also express the user cost of capital as a rate per dollar of capital?

Answer 19

r= depreciation rate + interest rate

Question 20

what is a isocost line?

Answer 20

it shows all possible combinations of labour and capital that can be purchased for a given total cost,

Question 21

what is the formula for a isocost line?

Answer 21

C (total cost) = wL (sum of a firm’s labour cost) + rK ( capital cost)

Question 22

if we rewrite the total cost equation as an equation for a straight line, what do we get?

Answer 22

K = C/r - (w/r) L

Question 23

what is the cost of labour?

Answer 23

the wage rate (w)

Question 24

what is the cost of capital?

Answer 24

the rental rate (r)

Question 25

how do you calculate the cost of labour?

Answer 25

the wage rate is multiplied by the amount of labour employed wL

Question 26

how do you calculate the cost of capital?

Answer 26

the rental rate is multiplied by the amount of capital rK

Question 27

therefore how do you calculate total cost in terms of input in capital and labour?

Answer 27

C (Q)= wL + rK

Question 28

what is the ratio of the input prices in terms of the isocost line?

Answer 28

-w/r

Question 29

what does the slope of the isocost line, which is the ratio of the input prices, tells us?

Answer 29

it tells us how much of one input (capital) we have to give up to get one more unit of the other input (labour) to maintain the same level of total cost

Question 30

what is an expansion path?

Answer 30

a curve passing through points of tangency between a firm’s isocost line and its isoquent

Question 31

in the expansion curve, what is the position of the short-run expansion path and why?

Answer 31

the short-run expansion curve is horizontal because one input (capital) and one input variable ( labour)

Question 32

in the expansion curve, what is the position of the long-run expansion path abd why?

Answer 32

the long run expansion curve is sloping upwards from the left to the right, going through cost-minimising lines because all inputs are variable

Question 33

when output increases, what happens to the firm’s average of cost of producing that output?

Answer 33

it is likely to decline

Question 34

what is economies of scale?

Answer 34

a situation in which output can be doubled for less than doubling the cost

Question 35

what is diseconomies of scale/increasing returns to scale?

Answer 35

a situation in which a doubling of output requires more than doubling of cost

Question 36

what is the shape of the long-run average cost that represents the economies of scale?

Answer 36

U-shape

Question 37

how is economies of scale measured and what is the formula?

Answer 37

economies of scale are often measured in terms of cost-output elasticity Ec. Ec is the percentage in the cost of production resulting from a 1-percentage increase in output Ec= (change in c/c) (change in quantity/quantity)

Question 38

to see how Ec relates to out traditional measures of cost, what is the equation and why is it like that?

Answer 38

Ec= (change in C/change in quantity) (c/quantity) = MC/AC Ec is equal to 1 when marginal and average costs are equal

Question 39

what happens when Ec is equal to 1 when marginal and average costs are equal?

Answer 39

cost increase proportionally when output and there are neither economies or diseconomies of scale

Question 40

what happens to marginal cost and average costs when there are economies of scale?

Answer 40

when there are economies of scale, marginal cost is less than average cost ( both declining) and Ec is less than 1

Question 41

What happens to marginal and average costs and Ec when there are diseconomies of scale?

Answer 41

when there are diseconomies of scale, marginal cost is greater than average cost and Ec is greater than 1

Question 42

what is a product transformation curve?

Answer 42

a curve showing the various combinations of 2 different outputs ( products) that can be produced with a given set of inputs

Question 43

what are economies of scope?

Answer 43

when the average cost of one product falls as the production of production of another product increases

Question 44

what are diseconomies of scope?

Answer 44

when the average cost of one product increases as the production of another good decreases

Question 45

what are degree of economies of scope? (SC) and what is the formula?

Answer 45

it is a percentage of cost savings resulting when 2 or more products are produced jointly rather than individually. SC= C(q1) + C(q2) - C(q1,q2)/ C(q1,q2)

Question 46

what is a learning curve?

Answer 46

graph showing how much input is needed by a firm to produce each unit of output to its cumulative output as the average cost falls

Question 47

what are the 4 forms of learning in a firm that decreases a firm’s average cost and making them more efficient over time?

Answer 47

1. overtime workers become more efficient at specific tasks they perform repeatedly 2. managers can observe production and adjust task assignments and other aspects of the production process 3. engineers can optimise product and plant design to increase efficiency 4. firms can get better at handling inputs, materials and inventories

Question 48

what is a cost function?

Answer 48

cost function is a function that shows the cost of production to level of output and other variables that the firm can control.

Question 49

what is the formula for the cost function?

Answer 49

C(x) = FC + V(x) ( C represents the total production cost, FC represents the total fixed cost, V represents the variable cost and x is the number of units)