Economics Chapter: Costs and Cost Functions

Explicit and Implicit Costs

• Explicit costs are direct, out-of-pocket payments made for resources.
• Implicit costs are the opportunity costs of using resources already owned by the firm.

Private Costs and Social Costs

• Private costs are the costs directly borne by the firm in producing a good or service.
• Social costs include both private costs and external costs, such as pollution.

Short Run vs. Long Run

• Short run: a period of time where some inputs are fixed (e.g., factory size) and others are variable.
• Long run: a period of time where all inputs are variable.

Cost Graphs

• Fixed Costs (FC): Costs that do not vary with output in the short run.
• Variable Costs (VC): Costs that change with the level of output.
• Total Costs (TC): The sum of fixed and variable costs.
• Average Fixed Costs (AFC): Fixed costs per unit of output (FC/Q).
• Average Variable Costs (AVC): Variable costs per unit of output (VC/Q).
• Average Total Costs (ATC): Total costs per unit of output (TC/Q).
• Marginal Costs (MC): The increase in total cost from producing one more unit of output.

Shape of the SRAC Curve

• The short-run average cost (SRAC) curve is U-shaped. Initially, it declines due to specialization and then rises due to the law of diminishing returns.

Specialization on Downward Part of Slope

• Specialization of labor and equipment leads to increased efficiency on the downward-sloping part of the SRAC curve.

Law of Diminishing Marginal Returns

• The principle that as more of a variable input is added to fixed inputs, the marginal output of the variable input eventually decreases.

Marginal Cost Curve

• The marginal cost (MC) curve intersects the average total cost (ATC) and average variable cost (AVC) curves at their minimum points.

Relationship Between Average Cost and Marginal Cost

• When MC is below ATC, ATC falls.
• When MC is above ATC, ATC rises.
• MC intersects ATC at the minimum point of ATC.

Long Run Average Cost Curve (LRAC) Shape and Explanation

• The long-run average cost (LRAC) curve is typically U-shaped.
• This U-shape is due to economies and diseconomies of scale.

Economies of Scale

• Internal economies of scale: reductions in average cost due to a firm expanding its size (e.g., bulk buying, increased specialisation, and efficient use of technology - factory size.
• External economies of scale: reductions in average cost due to factors outside a firm's control (e.g., improved local infrastructure, skilled labor pool)

This quiz covers key concepts in economics regarding explicit and implicit costs, private and social costs, and the differences between short run and long run. It also explores various cost graphs including fixed, variable, and total costs. Test your understanding of these fundamental economic principles.