Ch 7 Costs - Review

Describe the conditions under which a firm has economies of scale, diseconomies of scale, and constant economies of scale.

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. With diseconomies of scale, the firm's costs increase at a faster rate than the increase in output. Constant economies of scale indicate that the firm's costs increase at the same rate as the increase in output.

When does a producer face economies of scope? When does a producer face diseconomies of scope?

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 that producing the products separately. Diseconomies of scope indicate than a firm produces more than one product simultaneously at a higher cost than producing the products separately.

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.

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.

Define opportunity cost. How does a firm's opportunity cost relate to its economic cost?

Opportunity cost is the value of what a producer gives up by using an input. 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 costs but not in accounting cost.

What is the sunk cost fallacy?

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.

Why is a fixed cost curve horizontal? Why does a variable cost curve have a positive slope?

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.

Describe the relationship between fixed, variable, and total costs.

A firm's total cost is equal to the sum of its fixed and variable costs.

Name the three measures that examine a firm's per-unit cost at a given level of output.

Average fixed, average variable, and average total cost curves calculate a firm's fixed, variable, and total costs as costs per nit.

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?

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.

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.

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, the 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.

Why does a firm's fixed cost not affect its marginal cost of producing an additional unit of a product?

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, and is equal to marginal variable cost.