Firms production or closure decision (costs and supply)

Question 1

What are the two broad types of cost?

Answer 1

Fixed and variable costs

Question 2

What is a fixed cost?

Answer 2

These are costs incurred regardless of the scale of operation. i.e do not change with output

Question 3

What is a variable cost?

Answer 3

These vary according to the level of output of the firm.

Question 4

What are the different types of fixed costs?

Answer 4

Sunken costs, on going fixed costs and recuperable fixed costs

Question 5

What are sunken costs?

Answer 5

You incur these just once but can never get them back.

Question 6

What are ongoing fixed costs?

Answer 6

You incur them every time period.

e.g every year you rehire your office

Question 7

What are recuperable fixed costs?

Answer 7

These don’t vary with scale, but you can get them back.

Question 8

How do you workout short-run marginal costs?

Answer 8

(change in total variable costs)/(change in output)

Question 9

What is the short run?

Answer 9

The firm can only make partial adjustments of its inputs to a change in conditions as it operates in a given capacity
E.g. the firm may be able to vary the amount of labour, but cannot change capital.

Question 10

What is the long run?

Answer 10

A period long enough for the firm to adjust all its inputs to a change in conditions

Question 11

How do you work out long run marginal costs?

Answer 11

(change in all avoidable costs)/(change in output)

Question 12

What is a firms closure decision if is making a loss in the short term?

Answer 12

If is above fixed costs then they can’t make a profit and should close but if it less and above variable costs, they can survive and the accounts may write it off as an extraordinary loss

Question 13

What is the production function?

Answer 13

Specifies the maximum output which can be produced given inputs

Question 14

What is a factor of production?

Answer 14

A factor of production (“input”) is any good or service used to produce output

Question 15

What are the factors of production?

Answer 15

.1) Land
-Various types of land and natural resources
.2) Labour
-Different types of labour including acquired skills
3) Capital
-Various types of machinery, equipment, buildings etc.
-Reputational capital (requires investment )
-Should skills be seen as ‘human capital’?
4) Entrepreneurship

Question 16

What is the long run total cost curve?

Answer 16

The long run total cost curve describes the minimum cost of producing each output level when the firm is free to vary all input levels.

Question 17

What is the long run average cost? and usual shape?

Answer 17

. Total cost divided by the level of output.

. often assumed to be U-shaped

Question 18

What are economies of scale? and what causes it?

Answer 18

Economies of scale – or increasing returns to scale – occur when long-run average costs decline as output rises

1) fixed costs/ barriers to entry needed to enter industry-costs are spread as output increases
2) specialisation- more workers can have individual tasks and business becomes more efficient as output rises
3) large scale needed to cover costs of expensive macinery

Question 19

What are decreasing returns to scale?

Answer 19

Occur when long-run average costs rise as output rises

Question 20

What are constant returns to scale?

Answer 20

Occur when long-run average costs are constant as output rises

Question 21

What is the minimum efficient scale?

Answer 21

Lowest output at which the LAC curve reaches its minimum

Question 22

what is the firm’s long-run output decision in respect to LRAC, LRMC and MR?

Answer 22

. The marginal condition is found where LRMC=MR to find the best output provided the firm stays open
. LRAC is then compared at this output with the price to see if the best possible output yields a profit or a loss

Question 23

How do you work out SRTC?

Answer 23

Short-run total cost (STC) = short-run fixed cost (SFC) + short-run variable cost (SVC)

Question 24

What is the marginal product of labour

Answer 24

The marginal product of labour is the increase in output obtained by adding 1 unit of the variable factor(labour) but holding constant the inputs of all other factors (capital-machines).

Question 25

What is the law of dimishing returns?

Answer 25

Holding other thing constant, beyond some value of the variable input further increases in the variable input lead to steadily decreasing marginal product of that input.
E.g. trying to increase labour input without also increasing capital will bring diminishing returns

Question 26

Explain the firm’s short run output decision

Answer 26

. Firm sets output at Q1, where SMC=MR
. if price is above SATC1 firm produces Q1 at a profit
. if price is between SATC1 and SAVC1 firm produces Q1 at a loss but stays open in the the short run
. if price is below SAVC1 firm produces zero output.

Question 27

Explain the LRAC curve

Answer 27

LRAC curve is always below the SRAC curve, except at the point where they touch. Acts as an envelope of the SRAC curves. The LRAC curve shows the minimum cost way to produce a given output when all factors can be varied