3.2 Costs and economies of scale

• What are fixed costs?

  Costs that do not vary with output, such as rents, advertising, and capital goods.
• What are variable costs?

  Costs that change with output, such as the cost of raw materials.
• How is total cost calculated?

  Total cost is calculated by adding total variable costs and total fixed costs.
• What is the formula for average costs?

  Average costs are calculated by dividing total costs by the quantity produced.
• What does marginal cost represent?


  The cost of producing one extra unit.
• How does the short-run average cost (SRAC) vary with industry?

  The measure of the short run varies with industry, with no standard duration applicable to all.
• What does the law of diminishing marginal productivity state?

  It states that adding more units of a variable input to a fixed input increases output at first, but eventually leads to a decrease in the marginal increase of output.

  
• What happens to total costs when marginal output starts to fall?

  Total costs start to increase when marginal output begins to fall.
• What do the red parts on the cost diagram represent?

  The red parts show diminishing returns, where the cost of production starts to rise with increased output.
• How do marginal costs behave with increasing diminishing returns?

  Marginal costs rise with increasing diminishing returns.
• What is the relationship between the MC curve and the ATC and AVC curves?

  The MC curve cuts through the lowest points on the ATC and AVC curves.
• What defines the short run in production?

  In the short run, at least one factor of production cannot change, leading to some fixed costs.
• What is the difference between short run and long run in terms of costs?

  In the long run, all factor inputs can change, meaning all costs are variable.
• How does the short run vary across different industries?

  The measure of the short run varies with industry, with no standard duration applicable to all.
• What is the marginal return of a factor?

  The marginal return of a factor is the extra output derived per extra unit of the factor employed.
• What is the average return of a factor?

  The average return of a factor is the output per unit of input over a period of time.
• What is the total return of a factor?

  The total return of a factor is the total output produced by a number of units of factors over a period of time.
• When does the law of diminishing returns occur?

  Diminishing returns occur in the short run when variable factors are increased while fixed factors remain constant.
• How does the law of diminishing returns relate to productivity?

  The law assumes that firms have fixed factor resources in the short run and that productivity decreases as more variable inputs are added.
• What are returns to scale?

  Returns to scale refer to the change in output of a firm after an increase in factor inputs.
• What indicates increasing returns to scale?

  Increasing returns to scale occur when output increases by a greater proportion than the increase in inputs.
• What indicates decreasing returns to scale?

  Decreasing returns to scale occur when a doubling of input leads to a less than double increase in output.
• What are constant returns to scale?

  Constant returns to scale occur when output increases by the same amount that input increases by.
• What happens to average costs when fixed costs are high?

  When fixed costs are high, average costs are lowered as output increases.
• What occurs after the optimum level of output on the LRAC curve?

  After the optimum level of output, average costs rise due to diseconomies of scale.
• What is the minimum efficient scale?

  The minimum efficient scale is the point of lowest LRAC where costs are lowest and economies of scale have been fully utilized.
• How does the LRAC curve relate to the SRAC curve?

  The LRAC curve envelopes the SRAC curve and is always equal to or below it.
• What happens to SRAC as output increases?

  SRAC falls at first and then rises due to diminishing returns.
• What is the impact of external economies of scale on the LRAC curve?

  The LRAC curve shifts when there are external economies of scale, such as when an industry grows.
• What are internal economies of scale?

  Internal economies of scale occur when a firm becomes larger, leading to a fall in average costs as output increases.
• What does the mnemonic "Really Fun Mums Try Making Pies" represent?

  It represents examples of internal economies of scale: Risk-bearing, Financial, Managerial, Technological, Marketing, and Purchasing.
• How does risk-bearing function as an internal economy of scale?

  Risk-bearing allows larger firms to expand their production range and spread the cost of uncertainty.
• How does financial economy of scale benefit larger firms?

  Larger firms can obtain loans more cheaply because they are deemed less risky by banks.
• How does managerial economy of scale lower average costs?

  Larger firms can specialize and divide labor, employing specialist managers and supervisors.
• How does technological economy of scale affect production costs?

  Larger firms can invest in more advanced and productive machinery, lowering average costs.
• How does marketing economy of scale benefit larger firms?

  Larger firms can divide their marketing budgets across larger outputs, reducing average advertising costs per unit.
• How does purchasing economy of scale work?

  Larger firms can bulk-buy, leading to lower costs per unit due to greater negotiating power.
• What are network economies of scale?

  Network economies of scale are gained from the expansion of e-commerce, allowing large online shops to add goods and customers at low costs.
• What are external economies of scale?

  External economies of scale occur within the industry, benefiting all firms in the area.
• How can local infrastructure improvements serve as external economies of scale?

  Improvements in local roads can lower transport costs for local industries.