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Lecture 4 Costs of Production

Key Learning Points
This worksheet will develop your understanding of short and long run costs concepts, along with an in-depth examination of break-even analysis. An understanding of these issues is important for an understanding of cost drivers in the short and long run. Moreover, an understanding of break-even analysis is important for considering when a firm will operate, when it will shut down and when it will leave the market. This understanding will become especially useful when considering perfect competition in Chapter 5 of Begg and Ward.

  1. Variable costs change with the level of output.
True.   Variable costs do change with the level of output; fixed costs remain constant at all levels of output. See sections 3.1 and 3.3 of Begg and Ward.
  2. In the long run there are no fixed costs.
True.   In the long run all factors of production are variable and therefore all costs of using such factors must also be variable. See section 3.2 of Begg and Ward
  3. Economies of scale and diminishing returns are the same idea at different points in time.
False.   The law of diminishing returns and economies of scale do relate to different time periods, but they are also different ideas. The law of diminishing returns explains how average costs vary when a factor of production is fixed. Economies of scale explain how average costs vary when all factors of production are varied.
  4. Short run average costs are minimised where average costs equal marginal costs.
True.   See Figure 3.4 and 3.5 of Begg and Ward and the discussion ‘Relationship between the average and marginal’.
  5. In the long run, a firm may reduce its level of scale to reduce its average costs.
True.   If a company is too large, then it may experience diseconomies of scale. By downsizing it can move left along its long run average cost curve towards constant economies of scale. In so doing reduce its average costs. See Figure 3.8 of Begg and Ward.... [continues]

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