CH7: Cost Of Production

Question 2

What is a firm in economics?

Answer 2

A profit-seeking business that provides goods or services.

Question 3

What is the main goal of a firm in standard economic theory?

Answer 3

To maximize profit.

Question 4

What is the principal-agent problem?

Answer 4

A conflict where agents (e.g., managers) pursue goals not aligned with principals (e.g., owners).

Question 5

How is total revenue calculated?

Answer 5

TR = Price × Quantity sold.

Question 6

What is average revenue (AR)?

Answer 6

AR = Total Revenue ÷ Quantity sold.

Question 7

What is marginal revenue (MR)?

Answer 7

The additional revenue from selling one extra unit.

Question 8

What is profit?

Answer 8

Profit = Total Revenue – Total Cost.

Question 9

What are explicit costs?

Answer 9

Direct monetary payments for inputs.

Question 10

What are implicit costs?

Answer 10

Opportunity costs for using self-owned resources.

Question 11

What is normal profit?

Answer 11

The minimum return needed to keep resources in their current use; part of cost.

Question 12

What is economic cost?

Answer 12

Economic cost = Explicit costs + Implicit costs.

Question 13

What is accounting profit?

Answer 13

TR – Explicit Costs.

Question 14

What is economic profit?

Answer 14

TR – (Explicit + Implicit Costs), including normal profit.

Question 15

What defines the short run in production theory?

Answer 15

At least one input is fixed.

Question 16

What defines the long run in production theory?

Answer 16

All inputs are variable.

Question 17

What is total product (TP)?

Answer 17

The total output produced from inputs.

Question 18

What is average product (AP)?

Answer 18

AP = TP ÷ Input quantity.

Question 19

What is marginal product (MP)?

Answer 19

The additional output from using one more unit of input.

Question 20

What is the law of diminishing returns?

Answer 20

MP decreases as more units of a variable input are added to fixed inputs.

Question 21

What is total cost (TC)?

Answer 21

The total cost of producing a specific quantity of output.

Question 22

What is average cost (AC)?

Answer 22

AC = TC ÷ Quantity.

Question 23

What is marginal cost (MC)?

Answer 23

MC = Change in total cost ÷ Change in quantity produced.

Question 24

What happens when MC > AC?

Answer 24

Average cost increases.

Question 25

What happens when MC < AC?

Answer 25

Average cost decreases.

Question 26

What happens when MC = AC?

Answer 26

Average cost remains unchanged.

Question 27

What is the production function?

Answer 27

A mathematical relationship showing how inputs (e.g., labour and capital) are converted into output: Q = f(L, K).

Question 28

What is the difference between variable and fixed inputs?

Answer 28

Variable inputs change with output; fixed inputs stay constant in the short run.

Question 29

How is the short run defined in production theory?

Answer 29

A period during which at least one input is fixed.

Question 30

What does the law of diminishing returns state?

Answer 30

As more of a variable input is added to fixed inputs, the marginal product will eventually decline.

Question 31

What is total product (TP)?

Answer 31

The total quantity of output produced with given inputs.

Question 32

How is average product (AP) calculated?

Answer 32

AP = Total Product ÷ Units of Labour.

Question 33

What is marginal product (MP)?

Answer 33

The additional output from using one more unit of a variable input.

Question 34

What happens to AP when MP is above it?

Answer 34

AP increases.

Question 35

What happens to TP when MP becomes negative?

Answer 35

TP begins to decline.

Question 36

When is AP at its maximum?

Answer 36

When AP = MP.

Question 37

What is fixed cost (FC)?

Answer 37

Cost that does not vary with output.

Question 38

What is variable cost (VC)?

Answer 38

Cost that varies directly with output.

Question 39

How is total cost (TC) calculated?

Answer 39

TC = Fixed Cost + Variable Cost.

Question 40

How is average fixed cost (AFC) calculated?

Answer 40

AFC = Fixed Cost ÷ Output.

Question 41

How is average variable cost (AVC) calculated?

Answer 41

AVC = Variable Cost ÷ Output.

Question 42

How is average cost (AC) calculated?

Answer 42

AC = Total Cost ÷ Output.

Question 43

What is marginal cost (MC)?

Answer 43

MC = Change in Total Cost ÷ Change in Output.

Question 44

What is the shape of the MC, AVC, and AC curves?

Answer 44

U-shaped.

Question 45

What is the shape of the AFC curve?

Answer 45

L-shaped; it declines as output increases.

Question 46

What happens when MC < AC?

Answer 46

AC decreases.

Question 47

What happens when MC > AC?

Answer 47

AC increases.

Question 48

Where does MC intersect AVC and AC?

Answer 48

At their respective minimum points.

Question 49

What happens to marginal cost when marginal product increases?

Answer 49

Marginal cost decreases.

Question 50

When does average variable cost reach its minimum?

Answer 50

When average product is at its maximum.

Question 51

Why do MP and MC have an inverse relationship?

Answer 51

Because of the law of diminishing returns.

Question 52

In the long run, are there fixed inputs or fixed costs?

Answer 52

No. All inputs and costs are variable.

Question 53

Does the law of diminishing returns apply in the long run?

Answer 53

No, it only applies in the short run.

Question 54

What are returns to scale?

Answer 54

The relationship between input increases and resulting output increases when all inputs vary proportionally.

Question 55

What are constant returns to scale?

Answer 55

Output increases by the same percentage as inputs.

Question 56

What are increasing returns to scale?

Answer 56

Output increases by a greater percentage than inputs.

Question 57

What are decreasing returns to scale?

Answer 57

Output increases by a smaller percentage than inputs.

Question 58

What are economies of scale?

Answer 58

Reductions in average cost per unit as production increases.

Question 59

What causes internal economies of scale?

Answer 59

Factors within the firm, like better management or specialization.

Question 60

What are external economies of scale?

Answer 60

Cost savings due to external factors like improved infrastructure.

Question 61

What are diseconomies of scale?

Answer 61

Increases in average cost per unit as output rises.

Question 62

What are economies of scope?

Answer 62

Cost savings from producing related goods together in one firm.

Question 63

What does the long-run average cost (LRAC) curve show?

Answer 63

The lowest cost per unit at every output level when all inputs are variable.

Question 64

What shape does the LRAC curve have under economies of scale?

Answer 64

Downward-sloping.

Question 65

What happens when LRMC < LRAC?

Answer 65

LRAC is falling.

Question 66

What happens when LRMC > LRAC?

Answer 66

LRAC is rising.

Question 67

When does LRMC = LRAC?

Answer 67

At the minimum point of LRAC.

Question 68

What is the LRAC curve also called?

Answer 68

The envelope curve.

Question 69

How is the LRAC curve derived?

Answer 69

By joining the lowest points of all short-run average cost (SRAC) curves.

Question 70

Why is the LRAC curve smooth in theory?

Answer 70

Because it envelops an infinite number of SRAC curves.