Costs of Production

Question 1

Fixed & Variable Costs

Answer 1

• Fixed Costs: Costs which do not vary w/ output (e.g rents, advertising, capital goods)
• Variable Costs: Change w/ output (e.g cost of raw mats increases as output increases)

Question 2

Marginal, Average & Total Costs

Answer 2

• Marginal Cost: Cost of producing 1 extra unit. After a point, marginal costs rise as
  output increases
• Total Cost: Cost to produce a given level of output, calculated by:
  
  • Total Costs = Total Variable Costs + Total Fixed Costs
• Average Costs: Cost per unit/price, calculated by:
  
  • Average Costs = Total Costs / Quantity Produced

Question 3

Short Run Average Total Cost Curve

Answer 3

Short Run Average Total Cost Curve: U shaped due to diminishing returns
- Because FOP are fixed
- At one point, employing more resources will be less productive, meaning marginal output decreases per extra factor of production
- Marginal costs start to increase

Question 4

Long Run Average Cost Curve

Answer 4

Long Run Average Cost Curve: Initially, average costs fall, since firms take advantage of economies of scale
- Average costs are falling as output increases
- After optimum level of output, AC is lowest, AC rises due to diseconomies of scale

Question 5

How Factor Prices & Productivity Affect Firms’ Costs & Choice of Factor Inputs

Answer 5

• If factor inputs become more productive, firms produce more output w/ smaller input
• Results in lower unit costs of production.
• As AC of one FOP rises (e.g labour) firms likely to switch to cheaper (generally more productive) FOP (e.g capital)