CHAPTER 6: Costs Of Production

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1. Fixed factors- Inputs that cannot be easily and quickly changed. E.g.: Machines & Factory buildings

2. Variable factors- Inputs that can be easily and quickly changed.E.g.: Labour, raw materials & technology

3. Short run- The period of time during which at least one of the factors is fixed.

4. Long run- The period of time in which all the factors are variable.

5. The difference between short run and long run:- It is based on how long it takes for the firm to change its fixed factors of production into variable factors.

6. Explicit costs- Payments by firms to suppliers of inputs. E.g.: Loan interest and rent payment.

7. Implicit cost- The opportunity costs of factors owned by the firm. E.g.: Owner have earned $3000 by working for someone else.

8. The two laws of production
a) Law of diminishing return which operates only in the short run.
b) Law of return to scale which operates only in the long run.

9. Law of diminishing returns- When an extra units of variables factors are added to a fixed factors. Then, the marginal product gained from the employment of each extra units of this factor will go down.

10. Assumption behind the law of diminishing
a) There is only one fixed factor.
b) There is no technological progress.
c) There is no changes in the technique of production.

11. Output and Law of diminishing returns
a) The firm increases its output by employing more workers, using more raw materials and variable factors, it will first experience increasing returns. Increase in the amount of variable factors employed will lead to higher and higher increase in output.

b) The firm will experience diminishing returns. Each increase in the firm’s output will lead to slower increase in output. The average products and the marginal product are falling.

13. Fixed costs are costs that do not change with the quality of outputs. E.g.: Rental & Insurance

14. Variable costs are costs that change with unit of outputs. E.g.: Commission & Petrol

15. Calculate Total fixed cost

TFC= Average fixed cost X Output

16. Calculate Average fixed cost

AFC= Total fixed cost / Output

17. Calculate Total variable cost

TVC= Average variable cost X Output OR
TVC= Total cost - Total fixed cost

18. Calculate Average variable cost

AVC= Total variable cost / Output OR
AVC= Average total cost - Average fixed cost

19. Calculate Total cost

TC= Average total cost X Output OR
TC= Total fixed cost + Total variable cost

20. Calculate Average total cost

ATC= Total cost / Output OR
ATC= Average fixed cost + Average variable cost

21. Calculate Marginal cost

MC= Total cost n - Total cost n-1 (n= Number of units of output)

22. Firm- A single business unit with the aims of profit maximisation.

23. Industry- Groups of firms producing goods and services.

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24. Economies of scale- The advantages of large-scale production

25. There are 2 types of economies of scale
a) Internal economies of scale
b) External economies of scale

26. Internal economies of scale- The cost of advantages of large-scale production as the firm expands its output.

27. Categories of internal economies of scale
a) Technical- Expensive machinery are purchased are used. It is to ensure quick production and also to improve the quality of its product.
b) Marketing- Large firms can afford to advertise them product worldwide.
c) Administrative- In large companies, workers are assigned to do specialised tasks.
d) Financial- Large firms can also enjoy cheaper loan from banks.
e) Economies of research- The firm may be able to produce new products. Large firm can & development also undertake cheaper technique of production.

28. Internal diseconomies of scale- There will be an increase in costs as the firms expanding.

29. Categories of internal diseconomies of scale
a) Bureaucracy or red tape- When there is an expansion of the company, there will be more workers employed and this will lead to a greater problem of control, communication & coordination.
b) Negative effects of division of labour- It will lead to boredom and decline in labour productivity.
c) Marketing diseconomies

30. External economies of scale
a) Industry can benefit from the latest development without incurring additional costs with the economies of information.
b) They may enjoy benefits when that area well-known for a particular product.
c) Easier to set up the infrastructure for firms in the same industry if they are concentrated in one area.

31. External diseconomies of scale- When an industry keeps on expanding, the firm within the industry will begin to incur higher costs.

32. Categories of diseconomies of scale
a) Problem of pollution
b) The industry will offer higher wages to attract new worker .

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33. Survival of small firm / Why small firm can survive?
a) Some products have only a limited demand for village.
b) Some products require little capital.
c) Small firm can adapt itself quickly to changes in the customers requirement.

34. Law of returns of scale- There 3 stages of the law of returns to scale

a) Increasing returns to scale- If the inputs increase by 50%, then the level of output will increase by more than 50%. This is due to the internal economies of scale.

b) Constant returns to scale- If the inputs increase by 50%, then the level of output will also increase by 50%.

c) Decreasing returns to scale- If the inputs increase by 50%, then the total output will also increase but less than 50%. This is due to internal diseconomies of scale.