Flashcards in Chapter 7 - Costs Deck (35)
1. What is the difference between a firm's accounting and economic costs? How do these costs relate to a firm's accounting and economic profits?
1. Accounting costs include the direct costs of operating a business, while a firm's economic costs are its accounting costs plus its opportunity costs. A firm can calculate its profits in one of two ways: as accounting profits equal to its total revenue minus its accounting costs, or as economic profits equal to its total revenue minus its economic costs.
2. Define opportunity cost. How does a firm's opportunity cost relate to its economic cost?
2. Opportunity cost is the value of what a producer gives up by using an input, i.e. the value of the input's next-best use. A firm's opportunity costs are what differentiate the calculation of its accounting costs from that of its economic costs. Specifically, opportunity costs are included in economic cost but not in accounting cost.
3. What is the sunk cost fallacy?
3. A firm that lets its sunk costs affect its operating decisions has committed the sunk cost fallacy. In the forward-looking perspective, firms-and people-shouldn't allow costs that have already been paid and cannot be recovered to affect their decisions in the present.
4. Provide some examples of unavoidable fixed costs. How are these related to sunk costs? Describe why a firm should not consider sunk costs when making decisions.
4. Fixed costs include expenditures on overhead such as the cost of the building or plant and utility bills. Once paid, these types of expenditures become sunk costs, but a firm can avoid them by closing up shop and shutting down. Once they are sunk costs, however, the firm shouldn't take them into consideration when making production decisions. That would be committing the sunk cost fallacy, as we saw in Question 3 above.
6. Why is a fixed cost curve horizontal? Why does a variable cost curve have a positive slope?
6. A firm's fixed costs are constant no matter what its output level is, resulting in a horizontal fixed cost curve. The variable cost curve is positively sloped-as production increases, the associated variable costs increase.
7. Name the three measures that examine a firm's per unit cost at a given level of output.
7. Average fixed, average variable, and average total cost curves calculate a firm's fixed, variable, and total costs as costs per unit.
8. Why does a firm's fixed cost not affect its marginal cost of producing an additional unit of a product?
8. Since a firm's fixed cost does not vary with the level of output, fixed cost does not affect its marginal cost of producing an additional unit of output. That marginal cost is dependent only on the firm's variable cost
9. Why is a firm's short-run total cost greater than its long-run total cost? Explain why this is also true for a firm's short-run and long-run average costs.
9. In the short run, a firm has fixed costs on capital, while in the long run, the firm can vary both its capital and labor inputs. As a result, short-run total cost may be greater than long-run total cost. Since average cost is calculated as the total cost per unit of output, the same relationship holds true for a firm's short-run and long-run average costs.
The long-run average cost envelops all short-run average cost curves. The two curves touch where the chosen level of capital (capital is fixed in the short run) is actually optimal. but they need not coincide at minimum of short-run average cost…
10. Describe the conditions under which a firm has economies of scale, diseconomies of scale, and constant economies of scale.
10. Economies of scale look at the way a firm's costs increase with output.
A firm with economies of scale has costs that increase at a slower rate than the increase in output (average cost falls).
With diseconomies of scale, the firm's costs increase at a faster rate than the increase in output (average cost increases).
Constant economies of scale indicate that the firm's costs increase at the same rate as the increase in output (constant average cost).
11. When does a producer face economies of scope? When does a producer face diseconomies of scope?
11. Economies of scope look at how a firm's costs change when it produces more than one product. Economies of scope exist when a firm can produce more than one product simultaneously at a lower cost than producing the products separately. Diseconomies of scope indicate that a firm produces more than one product simultaneously at a higher cost than producing the products separately.
What is sunk costs?
Sunk costs - a cost that, once paid, the firm cannot recover. A fixed costs that you cannot avoid. If it is avoidable, it is not a sunk cost.
What is specific capital?
Whether capital can be used by another firm is an important determinant of sunk costs
Capital that is not very useful outside of its original application is called specific capital
What is a cost curve?
Cost curve - the mathematical relationship between a firm’s production costs and its output
There are different types of cost curves depending on what kind of costs we relate to the firm’s output
All cost curves are measured over a particular time period
The total cost curve shows how a firm’s total production cost changes with its level of output
What is marginal cost and how do we calculate it?
The cost of producing an additional unit of output.
MC = change in total cost/ 1 unit change in output
After a certain output level, marginal cost begins to rise, and at even higher output levels, it rises steeply. Why?
Marginal cost may initially fall at low quantities because complications may arise in producing the first few units that can be remedied fairly quickly, or because having more scale allows workers to specialize in those tasks that they are best at. As output continues to increase, however, these marginal cost reductions stop, and marginal cost begins to increase with the quantity produced
There are many reasons why it becomes more and more expensive to make another unit as output rises: Capacity constraints may occur, inputs may become more expensive as the firm uses more of them, it may be harder for the company to coordinate its operations, and so on.
What happens if the marginal cost of output is less than the average cost?
If the marginal cost of output is less than the average cost at a particular quantity, producing an additional unit will reduce the average cost because the extra unit's cost is less than the average cost of making all the units before it.
This means that if the marginal cost curve is below an average cost curve at some quantity, average cost must be falling-that is, the average cost curve is downward-sloping. This is true whether we're talking about average total cost or average variable cost, because the marginal cost of producing another unit of output creates the same increment to both total and variable cost. This is also true even if, as is often the case, marginal costs are rising while they are below average costs. Producing another unit of output at a cost below the firm's current average will still bring down the average even if that marginal cost is rising with output. Just remember that the marginal cost curve is the cost at a specific output level-how much it costs to produce that specific unit-while average costs are averaging over all the previous units' costs, too.
What happens when the marginal cost of the additional unit is above average cost?
When the marginal cost of the additional unit is above average cost, then producing it increases the average cost.
Therefore, if the marginal cost curve is above an average cost curve at a quantity level, average cost is rising, and the average cost curve slopes up at that quantity. Again, this is true for both average total cost and average variable cost. This property explains why average variable cost curves and average total cost curves often have a U-shape. If marginal cost continues to increase as quantity increases, it eventually rises above average cost and begins pulling up the average variable and average total cost curves. The only point at which there is no change in average cost from producing one more unit occurs at the minimum point of the average variable and average total cost curves, where marginal and average cost are equal.
What does flexibility of inputs depend on?
Time horizon: Over short time horizons, many inputs are fixed costs. As the time horizon expands, wait staff can be hired or fired, new capital can be purchased, and space can be expanded.
The presence of active capital rental and resale markets allow some capital expenditures to become variable (e.g., renting an extra webserver).
Flexibility of labor contracts: it may be difficult to fire workers, and firms may become reluctant to hire unless absolutely necessary.
What is the average cost?
Cost per unit of output C(Q)/Q
Where does the marginal cost curve cross the average cost curve?
The marginal cost curve crosses the average cost curve at the minimum of the average cost curve
Where are short-run and long-run marginal costs equal?
Short-run and long-run marginal costs are equal where the level of outputs for the fixed amount of capital is efficient. The long-run marginal cost curve connects the short-run marginal cist levels for efficient outputs.
How can we determine if a business should stay open?
If there is ECONOMIC profit they should
What is the difference between short-run and long-run cost curves?
Short-run cost curves relate a firm's production cost to its quantity of output when its level of capital is fixed. Long-run cost curves assume that a firm's capital inputs can change just as its labour inputs may.
Where do the marginal cost curves run through the average cost curve?
Marginal cost curves run through minimum of average cost curve
Why is short-run total and average total costs higher than their long-run values?
In the short run, the firm's capital inputs are held constant along its expansion path, and all changes in output come from changing labour inputs. This means that, for all quantities except that quantity at which the fixed capital level is cost-minimizing, short-run total and average total costs must be higher than their long-run values.
What is the relationship between the short-run and long-run average total cost curves?
Every fixed capital level has its own short-run cost curves. The long-run average total cost curve is an "envelope" of all the short-run average total cost curves.
Where does the long-run marginal cost equal the short-run marginal cost? How does the long-run marginal cost curve look compared to the short-run marginal cost curves?
Long-run marginal cost equals the short-run marginal costs at the quantities at which the fixed capital level is cost-minimizing. [Section 7.5] Long-run marginal cost curve is flatter than short-run marginal cost curves.
Define economies of scale, diseconomies of scale and constant economies of scale
Economies of scale - total cost rises at a slower rate than output rises
Diseconomies of scale - total cost rises at a faster rate than output rises
Constant economies of scale - total cost rises at the same rate as output rises
How does the long-run average total cost curve look when there is economies of scale, diseconomies of scale and constant economies of scale?
The long-run average total cost curve is downward-sloping when there are economies of scale, because total cost rises at a slower rate than quantity
Similarly, diseconomies of scale imply and upward-sloping long-run average total cost curve
Constant economies of scale make the long-run average total cost curve flat