Costs of production

Question 1

What is the marginal product of labour?

Answer 1

The extra output produced by an extra unit of labour (change in quantity/change in labour = MPL)

Question 2

What is the marginal product of capital?

Answer 2

The extra output produced by an extra unit of capital (change in quantity/change in capital). Applies more in long run factors

Question 3

What does an isoquant show?

Answer 3

All possible combinations of inputs that yield the same output

Question 4

What are isoquant maps used for?

Answer 4

Used to describe a production function. They are downward sloping and convex, and the slope at any point measures MRTS.

Question 5

What does a higher isoquant mean on an isoquant map?

Answer 5

Greater output (from both increasing capital and increasing labour on all points on a curve - like indifference curves)

Question 6

Isoquants enable us to assess relative costs. This means that:

Answer 6

If labour is expensive and machinery is cheap, a capital method of production would be more appropriate. If machinery is expensive and labour is cheap, a labour method of production would be more appropriate.

Question 7

What is the Marginal Rate of Technical Substitution (MRTS)?

Answer 7

How much we have to REDUCE one input when an extra unit of something else is used, so that the output remains constant

Question 8

What is the MRTS formula?

Answer 8

• change in capital / change in labour (Y axis/X axis)

Question 9

Why does the MRTS diminish?

Answer 9

As there is more labour, it becomes increasingly difficult to use labour intensive production methods (more capital is used for every unit of labour) - this is why the slope increasingly flattens further down

Question 10

What do straight isoquants show?

Answer 10

A constant MRTS (the rate at which capital and labour can be substituted is the same, no matter the level of input)

Question 11

What do L-shaped isoquants show?

Answer 11

Only one combination of L and K can be used to produce a given level of output (adding extra L or K does not increase output)

Question 12

What are returns to scale? (Nb. Scale = size of the business)

Answer 12

The boost to output (extra output) that we would receive if the business were to expand with more labour and capital [The rate at which output rises as inputs are both increased in the same proportion)

Question 13

What does an increasing return to scale mean?

Answer 13

Output more than doubles when inputs are doubled (require large amounts of both L and K, can use both more efficiently and produce more output; isoquants move closer together as inputs are increased)

Question 14

What does a constant return to scale mean?

Answer 14

Output doubles when all inputs are doubled (isoquants are equally spaced as output increases proportionally)

Question 15

What does a decreasing return to scale mean?

Answer 15

Output less than doubles when all inputs are doubled (increasingly difficult to deliver output efficiently the more K and L are used)

Question 16

Is MRTS more likely in the long or short term?

Answer 16

In the short term (the only way to produce more in a short time frame is to add units of labour, which can be inefficient - not enough time to generate new sources of capital through machinery, this is a long term concern)

Question 17

If capital is purchased, how do we work out the cost of using that capital?

Answer 17

The interest rate cost of the money used to buy it, plus depreciation costs (rate + depreciation)

Question 18

If capital markets were efficient, what would the rental costs and user costs be like?

Answer 18

They would be the same

Question 19

Total cost (C) of producing output (O) =

Answer 19

(market wage rage x wage) + (rental cost (interest + depreciation) x capital)

Question 20

What is the isocost equation?

Answer 20

K = C/r - (w/r)

Question 21

How do you work out the slope of the isocost line?

Answer 21

change in K/change in L = -(w/r) [wage rage / quantity of labour]

Question 22

What does the isocost line represent?

Answer 22

The ratio of the wage rate to the cost of capital

Question 23

What do ascots lines describe?

Answer 23

The combination of inputs that cost the same amount to the firm

Question 24

What does a tangent between the isocost line and the isoquant curve show?

Answer 24

The minimum cost of a given combination of labour and capital

Question 25

What happens to the isocost curve when the price of labour does up, relative to the price of capital?

Answer 25

It is steeper

Question 26

What do production costs include?

Answer 26

Capital costs, labour costs, cost of obtaining materials, components and energy

Question 27

What do indirect costs include?

Answer 27

Time and money that could have been obtained by investing money elsewhere

Question 28

What are total costs?

Answer 28

Fixed costs + Variable costs (FC+VC)

Question 29

What are average costs?

Answer 29

Total cost per unit of output produced: Total costs/Quantity

Question 30

What are averaged fixed costs?

Answer 30

Fixed cost per unit of output produced: AFC = FC/Q

Question 31

What are average variable costs?

Answer 31

The variable cost per unit of output produced: AVC = VC/Q

Question 32

The components of average total costs are:

Answer 32

AFC + AVC

Question 33

If a firm is creating more output, what does this mean in terms of cost?

Answer 33

Its fixed costs fall because the output is spread out across the machinery/equipment being used

Question 34

What does marginal cost show?

Answer 34

How production costs change as output changes; the change in total cost arising from the production of an extra unit of output [change in TC / change in Q]

Question 35

What is the cost component that changes in the short run?

Answer 35

Variable cost [marginal cost is equivalent to the change in VC incurred when output expands = change in VC / change in Q]

Question 36

What do marginal costs include?

Answer 36

The firm’s costs that vary with output - depends on the VC components; depends on the behaviour of the marginal product of labour and decreases as more labour is employed (change in VC / change in output)

Question 37

When output rises, what is the labour cost incurred?

Answer 37

Unit input cost of labour (wages) x no of extra labour units (L)

Question 38

What does it mean when MPL declines when output rises and more labour is employed?

Answer 38

This means that even if material costs per unit of output remain constant, the diminishing marginal productivity of labour must eventually cause marginal cost to rise as output rises

Question 39

On a graph, what does the marginal cost MC cross?

Answer 39

Crosses the average variable cost and average total cost curves at their minimum points