Unit 7: the cost of production Flashcards
what is economic costs?
these refers for implicit and explicit costs ( accounting expenses)
what are accounting costs?
these refers to explicit costs only
what are sunk costs?
these refers to costs that have been incurred by and cannot be recovered
what are fixed costs (FC)
these refers to costs that don’t depend on output
what are variable costs? (VC)
these refers to the costs that depend on output
what are total costs? (TC) and what is the formula for TC?
this refers to the sum of fixed costs. TC= FC + VC
what are average variable costs? what is the formula?
these refers to the variable costs per unit output. AVC= VC/Q
what is average total costs? and what is the formula?
this refers to the total costs per unit of output. ATC= TC/Q
what is the margins cost and what is the formula?
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)
how do we know that a cost is fixed?
they’re costs over a short period of time.
how do we know that a cost is a variable cost?
a cost over a longer period of time
what is short-run in terms of the factors of production and input?
it is a period which at least one factor of production/input is fixed
what is long-run in terms of the factors of production/inputs?
it is a period which all factors of production/inputs change
what are the diminishing marginal returns and marginal cost?
the marginal product of labour decreases as the quantity of labour employed increases
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?
MC= change in variable cost/change in quantity = wages timed change in labour/ change in quantity
in short-run curves, what is the relationship between marginal ( MC) and average cost curves? ( 3 points)
- when MC< ATC, then ATC decreases
- when MC > ATC, then ATC increases
- ATC at minimum, then MC= ATC. Normal profit earned and point of efficiency
in short-run curves, what is the relationship between average cost (ATC), average variable cost ( AVC) and average fixed cost ( AFC) ?
ATC= AVC + AFC
Distance between ATC and AVC decreases as AFC decreases and output increases
what is the user cost of capital and what is the formula for it?
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)
how can we also express the user cost of capital as a rate per dollar of capital?
r= depreciation rate + interest rate
what is a isocost line?
it shows all possible combinations of labour and capital that can be purchased for a given total cost,
what is the formula for a isocost line?
C (total cost) = wL (sum of a firm’s labour cost) + rK ( capital cost)
if we rewrite the total cost equation as an equation for a straight line, what do we get?
K = C/r - (w/r) L
what is the cost of labour?
the wage rate (w)
what is the cost of capital?
the rental rate (r)
how do you calculate the cost of labour?
the wage rate is multiplied by the amount of labour employed wL
how do you calculate the cost of capital?
the rental rate is multiplied by the amount of capital rK
therefore how do you calculate total cost in terms of input in capital and labour?
C (Q)= wL + rK
what is the ratio of the input prices in terms of the isocost line?
-w/r
what does the slope of the isocost line, which is the ratio of the input prices, tells us?
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
what is an expansion path?
a curve passing through points of tangency between a firm’s isocost line and its isoquent
in the expansion curve, what is the position of the short-run expansion path and why?
the short-run expansion curve is horizontal because one input (capital) and one input variable ( labour)
in the expansion curve, what is the position of the long-run expansion path abd why?
the long run expansion curve is sloping upwards from the left to the right, going through cost-minimising lines because all inputs are variable
when output increases, what happens to the firm’s average of cost of producing that output?
it is likely to decline
what is economies of scale?
a situation in which output can be doubled for less than doubling the cost
what is diseconomies of scale/increasing returns to scale?
a situation in which a doubling of output requires more than doubling of cost
what is the shape of the long-run average cost that represents the economies of scale?
U-shape
how is economies of scale measured and what is the formula?
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)
to see how Ec relates to out traditional measures of cost, what is the equation and why is it like that?
Ec= (change in C/change in quantity) (c/quantity) = MC/AC
Ec is equal to 1 when marginal and average costs are equal
what happens when Ec is equal to 1 when marginal and average costs are equal?
cost increase proportionally when output and there are neither economies or diseconomies of scale
what happens to marginal cost and average costs when there are economies of scale?
when there are economies of scale, marginal cost is less than average cost ( both declining) and Ec is less than 1
What happens to marginal and average costs and Ec when there are diseconomies of scale?
when there are diseconomies of scale, marginal cost is greater than average cost and Ec is greater than 1
what is a product transformation curve?
a curve showing the various combinations of 2 different outputs ( products) that can be produced with a given set of inputs
what are economies of scope?
when the average cost of one product falls as the production of production of another product increases
what are diseconomies of scope?
when the average cost of one product increases as the production of another good decreases
what are degree of economies of scope? (SC) and what is the formula?
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)
what is a learning curve?
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
what are the 4 forms of learning in a firm that decreases a firm’s average cost and making them more efficient over time?
- overtime workers become more efficient at specific tasks they perform repeatedly
- managers can observe production and adjust task assignments and other aspects of the production process
- engineers can optimise product and plant design to increase efficiency
- firms can get better at handling inputs, materials and inventories
what is a cost function?
cost function is a function that shows the cost of production to level of output and other variables that the firm can control.
what is the formula for the cost function?
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)
