Chapter 4

Question 1

Costs exist because

Answer 1

resources are scare, productive and have alternative uses.

Question 2

Economic cost/Opportunity cost

Answer 2

When society uses a combination of resources to produce a particular product, it forgoes all alternative opportunities to use those resources for other purposes.

Question 3

Explicit Costs

Answer 3

The monetary payments (or cash expenditures) the firm makes to those who supply labour services, materials, fuel, transportation services etc. Such money payments are for the use of resources owned by others.

Question 4

Implicit Costs

Answer 4

The opportunity costs of using self-owned, self-employed resources. To the firm, they are the money payments that self-employed resources could have earned in their best alternative use.

Question 5

Normal Profit

Answer 5

The payment made by a firm to obtain and retain entrepreneurial ability or the minimum income that entrepreneurial ability must receive to induce it to
perform entrepreneurial functions for a firm.

Question 6

Economic Profit

Answer 6

The total revenue minus total costs (both explicit and
implicit, the latter including normal profit to the
entrepreneur).

Question 7

Short Run

Answer 7

A period too brief for a firm to alter its plant capacity, yet long enough to permit a change in the degree to which the fixed plant is used.

Question 8

Long Run

Answer 8

A period long enough for a firm to adjust the quantities of all the resources that it employs, including plant capacity.

Also enough time for new firms to enter and old firms to leave an industry.

Question 9

Total product (TP)

Answer 9

The total quantity, or total output, of a particular good or service produced.

Question 10

Marginal product (MP)

Answer 10

The extra output or added product associated with adding a unit of a variable resource to the production process

Question 11

MP =

Answer 11

MP = Change in total product/Change in input
(MU = ΔΤP/ Δinput)

Question 12

Average product (AP)

Answer 12

Output per unit of input

Question 13

AP =

Answer 13

AP = ATP/input

Question 14

The Law of Diminishing Returns

Answer 14

(Assuming that technology is fixed) As successive units of a variable resource are added to a fixed resource, beyond some point the extra or marginal product that can be attributed to each additional unit of the variable resource will decline.

Question 15

Fixed Costs (FC)

Answer 15

Costs that in total do not vary with changes in output. They are associated with the existence of a firm’s plant and therefore must be paid even if its output is zero.

Question 16

Variable Costs (VC)

Answer 16

Costs that change with the level of output. They are associated with payments for inputs to the production process.

Question 17

Total Cost (TC)

Answer 17

The sum of fixed cost and variable cost at each level of output.

Question 18

TC =

Answer 18

TC = TFC + TVC

Question 19

Average fixed cost (AFC)

Answer 19

Calculated by dividing total fixed cost (TFC) by each level of output (Q)

Question 20

AFC =

Answer 20

AFC = TFC/Q

Question 21

Average variable cost

Answer 21

Calculated by dividing total variable cost (TVC) by each level of output (Q)

Question 22

AVC =

Answer 22

AVC = TVC/Q

Question 23

Average total cost

Answer 23

Calculated by dividing total cost (TC) by each
level of output (Q)
or by adding average fixed cost (AFC) and average variable cost (AVC) at that output

Question 24

ATC =

Answer 24

ATC = TC/Q
TFC/Q + TVC/Q
AFC + AVC

Question 25

Marginal Cost (MC)

Answer 25

The extra cost of producing one more unit of output

Question 26

MC =

Answer 26

MC = Change in TC/Change in Q (MC= ΔΤC / ΔQ)

Question 27

Firm Size and Cost: Long run

Answer 27

Larger plants will lower ATC however; eventually a still larger plant may cause ATC to rise.

Question 28

Long Run Cost curve

Answer 28

shows the lowest ATC at which any output level can be produced after the firm has time to make appropriate adjustments. The long-run ATC curve is made up of segments of short-run ATC curves for the various plant sizes. The vertical lines perpendicular to the output axis indicate the level of output at which the firm should change plant size to realize the lowest attainable ATC.

Question 29

Economies of Scale

Answer 29

Explains the downward-sloping part of the long-run ATC curve. As plant size increases, a number of factors will for a time lead to lower average costs of production: - labour specialization - managerial specialization - efficient capital - other factors

Question 30

Labour specialization

Answer 30

Increased specialization in the use of labour becomes more achievable as a plant increases in size. Workers can work full time on the tasks for which they have special skills. Workers can become more proficient at those tasks Eliminates the loss of time of workers switching tasks.

Question 31

Managerial Specialization

Answer 31

Better use of and greater specialization in management. Leads to greater efficiency and lower unit costs.

Question 32

Efficient Capital

Answer 32

Efficient equipment is available only in large and expensive units. Effective use of the equipment demands a high volume of production.

Question 33

Diseconomies of scale

Answer 33

Explain the upward-sloping part of the long-run ATC curve: As plant size keeps increasing, a number of factors will lead eventually to higher average costs of production.

Question 34

Main factor causing diseconomies of scale:

Answer 34

The difficulty of efficiently controlling and coordinating a firm's operations as it becomes a large-scale producer.

Question 35

Returns to scale

Answer 35

Refers to the long-run relationship between inputs and outputs. As all inputs change by a certain percentage, the following changes in output may result: Constant returns to scale Decreasing returns to scale Increasing returns to scale

Question 36

Constant returns to scale

Answer 36

a given % increase in inputs will give rise to the same % increase in output.

Question 37

Decreasing returns to scale

Answer 37

a given % increase in inputs will give rise to a smaller % increase in output.

Question 38

Increasing returns to scale

Answer 38

a given % increase in inputs will give rise to a larger % increase in output.

Question 39

Minimum efficient scale (MES)

Answer 39

The lowest level of output at which a firm can minimize long-run average costs.

Question 40

Can small firms realize the MES?

Answer 40

Given demand, efficient production will be achieved with a few large-scale producers. Small firms cannot realize the minimum efficient scale and will not be able to compete

Question 41

Natural Monopoly

Answer 41

A relatively rare market situation in which average total cost is minimized when only one firm produces the particular good or service. Results when economies of scale extend beyond the market's size