Cost Function Overview

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Questions and Answers

What happens to average and marginal costs when the average product and marginal product are rising?

  • Both average and marginal costs decrease (correct)
  • Average cost increases while marginal cost decreases
  • Average cost decreases while marginal cost increases
  • Both average and marginal costs increase

Average fixed cost remains constant regardless of the level of output.

False (B)

What does U-shaped average and marginal costs imply about production?

It implies that costs fall to a minimum and then begin to rise due to the law of diminishing marginal product.

When a firm is experiencing increasing returns to variable inputs, the average and marginal costs are ______.

<p>decreasing</p>
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Match the following terms with their definitions:

<p>Marginal Cost = Cost of providing one more unit Average Total Cost = Total cost divided by output Average Variable Cost = Variable cost divided by output Average Fixed Cost = Fixed cost divided by output</p>
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What is the relationship between cost and price?

<p>Cost determines the price and profit from sales (C)</p>
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Implicit costs are the payments made to non-owners for resources utilized.

<p>False (B)</p>
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What are explicit costs?

<p>Payments made to non-owners for resources used in production.</p>
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The total fixed cost remains the same regardless of the level of ______.

<p>output</p>
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Match the following types of costs with their descriptions:

<p>Explicit cost = Payment made to non-owners for resources Implicit cost = Opportunity cost of owned resources Total fixed cost = Cost that stays the same regardless of production Total variable cost = Cost that varies with the level of production</p>
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Which of the following is an example of implicit cost?

<p>Interest earnings from a bank account (D)</p>
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What must a firm at least earn to cover its implicit costs?

<p>$300,000</p>
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What happens to total variable cost when the output is zero?

<p>It is equal to zero. (B)</p>
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Total cost is the sum of total variable cost and total fixed cost.

<p>True (A)</p>
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What does AFC stand for in cost analysis?

<p>Average Fixed Cost</p>
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As output increases, total variable cost also ____.

<p>increases</p>
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Match the costs with their definitions:

<p>TC = Total Cost TFC = Total Fixed Cost TVC = Total Variable Cost AFC = Average Fixed Cost</p>
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Which of the following is a component of total cost?

<p>Total Fixed Cost (D)</p>
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Average Total Cost can only be calculated by dividing total cost by the quantity of output.

<p>False (B)</p>
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Provide an example of a variable cost.

<p>Labor, utility, or raw materials</p>
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The formula for Average Total Cost (ATC) is ___ = TC/Q.

<p>Average Total Cost</p>
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Flashcards

Cost Function

The relationship between a firm's output and the cost of producing that output.

Explicit Cost

Payments made to non-owners for resources used by a firm (e.g., salaries, materials).

Implicit Cost

Opportunity cost of resources owned by the firm (e.g., owner's salary, rent for owned building).

Total Fixed Cost

The cost that does not change with the level of output.

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Total Variable Cost

The cost that varies directly with the level of output.

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Cost

The expense incurred in producing a product or service.

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Price

The amount a customer is willing to pay for a product or service.

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Marginal Cost (MC)

The cost of producing one more or one less unit of output.

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Average Cost (AC)

The total cost divided by the quantity of output produced, representing the cost per unit.

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U-shaped Cost Curves (TC, ATC, AVC)

Typical cost curves (except AFC) initially decrease, reach a minimum, and then increase due to diminishing marginal returns.

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Diminishing Marginal Returns

Adding more variable inputs (like workers) results in smaller and smaller increases in output. Eventually, adding more causes output to decrease.

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Average Fixed Cost (AFC)

Total fixed cost divided by the quantity of output.

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Total Cost

The sum of all costs incurred in producing a given level of output. It includes both fixed and variable costs.

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Fixed Cost

Costs that remain constant regardless of the level of output. These costs are incurred even if no output is produced.

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Variable Cost

Costs that fluctuate directly with the level of output. They increase as production increases and decrease as production decreases.

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Average Total Cost (ATC)

The total cost per unit of output. It's calculated by dividing the total cost by the quantity produced.

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Average Variable Cost (AVC)

The variable cost per unit of output. It's calculated by dividing the total variable cost by the quantity produced.

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Marginal Cost

The additional cost incurred by producing one more unit of output.

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Relationship between TC, TFC, and TVC

Total Cost (TC) is always equal to the sum of Total Fixed Cost (TFC) and Total Variable Cost (TVC). This relationship holds true at any level of output.

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How is ATC calculated?

Average Total Cost (ATC) can be calculated in two ways: 1) Dividing total cost (TC) by the quantity of output (Q); 2) Adding Average Fixed Cost (AFC) and Average Variable Cost (AVC).

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Unit Costs

Costs expressed per unit of output. They help businesses understand the cost of producing each individual item.

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Study Notes

Cost Function

  • Cost is the expense of producing a product or service.
  • Price is what a customer pays.
  • Cost directly affects price and profit.
  • Cost function describes the relationship between output and production cost.
  • Cost includes input prices multiplied by the quantity of inputs.
  • Economic cost is more than just historical cost; it includes opportunity cost (the value of the next best alternative use of resources).

Types of Cost

  • Explicit costs: Payments to non-owners for resources (salaries, materials).
  • Implicit costs: Opportunity costs of resources owned by the firm (entrepreneur's salary, building rent). Total implicit cost = $300,000

Cost Based on Variation with Production

  • Total fixed costs: Costs for fixed resources (buildings, machinery, insurance). Does not change with output level.
  • Total variable costs: Costs that change with the level of output; (labor, utilities, raw materials).

Unit Cost

  • Total cost (TC): Total fixed cost + Total variable cost.
  • Average total cost (ATC): Total cost / Quantity of output.
  • Average fixed cost (AFC): Total fixed cost / Quantity of output.
  • Average variable cost (AVC): Total variable cost / Quantity of output.
  • Marginal cost (MC): Change in total cost from producing one more unit.
  • Average cost curves are U-shaped (falling, then rising).
  • Marginal cost curves intersect (cross) Average cost curve at the minimum point of average cost.
  • When marginal cost is below average total cost (ATC), ATC falls.
  • Marginal cost and average costs are directly related: when MC is below ATC, ATC is decreasing. When MC is above ATC, ATC is increasing.

Relationship Between Average and Marginal Costs

  • When marginal cost is below average cost, average cost falls.
  • When marginal cost is above average cost, average cost rises.
  • Average cost is lowest where it intersects marginal cost.

Relationship Between Cost and Output

  • Total variable cost changes directly with the level of output.
  • Fixed costs remain the same regardless of output level.

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