Chapter 13 - The Costs of Production

Question 1

Define Total Revenue (for a firm).

Answer 1

The amount a firm receives for the sale of its output.

Question 2

Define Total Cost.

Answer 2

The amount a firm pays to buy the inputs into production.

Question 3

Define Profit.

Answer 3

Total Revenue - Total Cost

Question 4

Define Firms

Answer 4

Economic units formed by profit-seeking people. They employ resources to produce goods and services for sale. Firms help reduce transaction costs (cost involved in negotiating).

Question 5

Important note about costs.

Answer 5

All resources have an opportunity cost.

Question 6

What are the two types of opportunity cost?

Answer 6

1. Explicit Cost - opportunity cost of resources that take the form of a cash payment. (eg. computers, equipment, etc)
2. Implicit Cost - the opportunity cost of a firm using its own resources (or those provided by its owners) without corresponding cash payment. (eg. opportunity cost of owner’s time (i.e. could be working for another firm earning a wage.)

Question 7

Explain how an accountant and economist view the cost of capital?

Answer 7

For example, if a business borrows money from the bank which comes with a 10% interest, this 10% interest will be considered as an implicit cost as it could have been spent elsewhere. However, an accountant does not count this as a cost at all as no money is flowing out of the business.

Question 8

What is the difference between accounting and economic profit?

Answer 8

Accounting profit = total revenue - explicit costs only.

Economic profit = total revenue - explicit & implicit costs.

Question 9

What does it mean when economic profit = 0?

Answer 9

That means that the return to the owner is equal of that of the next best alternative.

Question 10

Define short run.

Answer 10

At least one of the factors of production are fixed (typically capital).

Question 11

Define long run.

Answer 11

All factors of production are variable.

Question 12

Define Production function/theory.

Answer 12

The relationship between the input required to make a good and the quantity of output of that good.

Question 13

What are the inputs (factors of production) that affect outputs?

Answer 13

1. Land, labour, capital, entrepreneurship (profit).
2. By convention we focus largely on two - Labour (L) and Capital (K).
3. We also need to distinguish between the short run and the long run.

Question 14

Define Marginal Product (MP).

Answer 14

The extra output produced when the variable factor is increased by one unit.

Question 15

Define Diminishing Marginal Product/Returns.

Answer 15

When the marginal product of an input declines as the quantity of the input increases.

• assuming labour is homogenous

Question 16

What is the difference between the Production function and the Total Cost Curve.

Answer 16

• The production function rises until it reaches a detrimental point where the rate of production drops.
• The total-cost curve rises until it reaches that same point as the production function; the total cost then increases at a much faster rate.

Question 17

Why is diminishing returns a ‘law’?

Answer 17

As long as one factors of production is fixed (short run), the rate of increasing outputs must eventually decrease.

+If we didn’t, we could feed the world from a flowerpot, simply by adding more labour and fertiliser.

Question 18

List all the returns to scale.

Answer 18

1. Constant - 1:1
2. Increasing - if you double all inputs, output more than doubles.
3. Decreasing - if you double all inputs, output increases by less than double.

Question 19

What are the two types of production costs?

Answer 19

1. Fixed Costs

2. Variable Costs

Question 20

Define Fixed Costs.

Answer 20

Costs that do not vary at all, it is independent of that quantity of output.

eg. rental, hire of a full-time bookkeeper.

Question 21

Define Variable Costs.

Answer 21

Costs that vary depending on the quantity of output.

eg. cost of goods sold.

Question 22

Total Cost?

Answer 22

TC = TFC + TVC

Question 23

Average Total Cost?

Answer 23

ATC = TC/Q

Question 24

Average Fixed Cost?

Answer 24

AFC = FC/Q

Question 25

Average Variable Cost?

Answer 25

AVC = VC/Q

Question 26

Define Efficient Scale.

Answer 26

The quantity of output that minimises average total cost.

Question 27

Explain the relationship between marginal cost and average total cost.

Answer 27

Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising.

Question 28

3 properties that the cost curves share.

Answer 28

1. Marginal cost eventually rises with the quantity of output. 2. The average-total-cost curve is U-shaped. 3. The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.

Question 29

Define economies of scale.

Answer 29

When long-run average total cost declines as output increases.

Question 30

Define diseconomies of scale.

Answer 30

When long-run average total cost rises as output increases,

Question 31

Define constant returns to scale.

Answer 31

When long-run average total cost does not vary with the level of output.

Question 32

What might cause economies or diseconomies of scale?

Answer 32

Economies of scale often arise because higher production levels allow specialisation among workers, which permits each worker to become better at his or her assigned tasks.