Week 5 - costs of production

Question 1

explain total revenue, total costs and profit

Answer 1

Total revenue is the total amount (in $) a firm receives for the sale of its output.
• Total cost is the total amount (in $) a firm pays to purchase the inputs into production.

• Profit is the firm’s total revenue minus its total cost.
Profit = total revenue − total cost

Question 2

define marginal product

Answer 2

Increase in output that arises from additional units of input

Question 3

Define marginal cost

Answer 3

Increase in total cost that arises from an extra unit of input
Marginal cost helps answer the following question:
• How much does it cost to produce an additional unit of
output?

Marginal costs = Change in total costs / change in total quantity

Question 4

difference between accountant and economist

Answer 4

economist includes all opportunity costs when allaying a firm where as accountant measure only explicit costs, therefore eco profit is smaller than accounting profit

Explicit costs are input costs that require a direct outlay of money by the firm.
• Implicit costs are input costs that do not require an outlay of money by the firm

When total revenue exceeds both explicit and implicit costs, the firm earns economic profit.

Question 5

Explain difference between short term and long run

Answer 5

Long run = the period of time needed for all the factors of production to become variable

Short term = A period of time during which at least one factor of production is fixed

For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.
– In the short run, many costs are fixed.
– In the long run, fixed costs become variable costs.

Businesses have to make 2 key decisions
• How much to produce
• What do I charge

Question 6

Define diminishing marginal product

Answer 6

The property whereby the marginal product of an input declines as the quantity of the input increases

• Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment.

Question 7

Define production function

Answer 7

relationship between quantity of inputs used and the quantity of output of that good

Question 8

The slope of the production function measures the

Answer 8

marginal product of an input, such as a worker.
– When the marginal product declines, the production function becomes flatter.
– Lower the cost the better due to scarcity
– Competition forces firms to compete at the lowest point

Question 9

Costs of production can be divided into 2 types:

Answer 9

– Fixed = costs that do not vary with the quantity of output produced (sunk costs) e.g. uni fees, rent

– Variable = Costs that vary with the quantity of output produced

Question 10

Define average total costs

Answer 10

Average total costs = Total cost divided by the quantity of output

Question 11

Define average fixed costs

Answer 11

Average fixed costs = fixed costs divided by the quantity of output

Question 12

define average variable costs

Answer 12

Average variable costs = variable costs divided by the quantity of output

Question 13

Define marginal costs

Answer 13

Marginal costs = The increase (difference) in total costs that arises from an extra unit of production

Question 14

3 important properties of cost curves

Answer 14

– Marginal cost eventually rises with the quantity of output.
– The average-total-cost curve is U-shaped.
– The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.

Question 15

Define economies of scale

Answer 15

– Economies of scale refer to the property whereby long-run average total cost falls as the quantity of output increases.

Question 16

Explain diseconomies of scale

Answer 16

Diseconomies of scale refer to the property whereby long-run average total cost rises as the quantity of output increases.
– (opposite to diseconomies of scale?)

Question 17

Define constant rate to scale

Answer 17

Constant returns to scale refers to the property whereby long-run average total cost stays the same as the quantity of output changes.

Returns to scale measures the effect on average costs as scale is changed
• Scale refers to the proportionate change in all inputs
• For example, CRTS means a 10% increase in ALL inputs increases average costs by 10%: costs rise the same % as inputs.

Increasing returns of scale:
Scale refers to the proportionate change in inputs
• For example, IRTS means a 10% increase in ALL inputs increases average costs by only 5%: costs rise less than the increase in scale

Question 18

Distinguish between short and long term

Answer 18

The short run refers to a period of time when at least one factor is fixed, not to a specific calendar time. It can vary in length of time, depending on the industry. For example, the building on a new factory cannot be achieved overnight if you wished to establish a steel manufacturing plant, whereas a dog walking service can be established almost overnight. The long run refers to a period of time in which the quantities of all inputs can be varied.
e.g. the input that cannot be changed in the short term is the factory itself where as the long run period of time needed for all factors of production to become variable

Question 19

What is your aunt’s opportunity cost of running a hardware store for a year?
If your aunt thought she could sell $510,000 worth of merchandise in a year, should she open the store? Explain.

Answer 19

The opportunity cost of running the hardware store is $550,000, consisting of $500,000 to rent the store and buy the stock and a $50,000 opportunity cost, since your aunt would quit her job as an accountant to run the store. Since the total opportunity cost of $550,000 exceeds revenue of $510,000, your aunt shouldn’t open the store, as her profit would be negative. She would lose money

Marginal Product is the increase in output that arises from an additional unit of input. Marginal product rises at first, then declines because of diminishing returns (diminishing marginal product)

Question 20

Learn on formulas + weeks graphs

Answer 20

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