4.1.4.4 Costs of production (AQA Economics)

This AQA Economics Study Note covers costs of production

Understanding Costs of Production

1. Difference Between Fixed and Variable Costs:Fixed Costs:

1. Definition:
   • Fixed Costs are expenses that remain constant regardless of the level of production.
2. Example:
   • Rent for a factory space remains the same, whether the factory produces 100 units or 1,000 units.

Variable Costs:

1. Definition:
   • Variable Costs change with the level of production.
2. Example:
   • The cost of raw materials increases as production volume rises; therefore, it is a variable cost.

2. Difference Between Marginal, Average, and Total Costs:

Marginal Costs:

1. Definition:
   • Marginal Costs represent the additional cost incurred by producing one more unit of output.
2. Example:
   • If producing 10 units costs $100, and producing 11 units costs $110, the marginal cost of the 11th unit is $10.

Average Costs:

1. Definition:
   • Average Costs are the total cost per unit of output.
2. Example:
   • If producing 100 units costs $1,000, the average cost per unit is $10 (1000/100).

Total Costs:

1. Definition:
   • Total Costs encompass all costs, both fixed and variable, incurred in the production process.
2. Example:
   • If fixed costs are $500 and variable costs for producing 100 units are $1,000, the total cost is $1,500.

Difference Between Short-Run and Long-Run Costs:

Short-Run Costs:

1. Definition:
   • Short-Run Costs include both fixed and variable costs, but some factors (like the size of the factory) are fixed.
2. Example:
   • A bakery can increase production by hiring more workers in the short run, but it cannot build a larger facility immediately.

Long-Run Costs:

1. Definition:
   • Long-Run Costs encompass all costs, and all factors of production, including the size of the facility, can be adjusted.
2. Example:
   • The bakery can build a larger facility in the long run to accommodate increased production.

Reasons for the Shape of Cost Curves:

Marginal Cost Curve:

1. U-Shaped Curve:
   • Initially decreases due to increasing specialization, then increases due to diminishing returns.

Average Cost Curve:

1. U-Shaped Curve:
   • Similar to the marginal cost curve, reflecting economies of scale and then diseconomies of scale.

Total Cost Curve:

1. Rises Steadily:
   • Due to the fixed costs that remain constant regardless of production level.

How Factor Prices and Productivity Affect Costs:

Factor Prices:

1. Effect:
   • Higher wages or costs of raw materials increase variable costs.
2. Example:
   • If the price of steel rises, a car manufacturing company experiences an increase in variable costs.

Productivity:

1. Effect:
   • Improved productivity lowers average and total costs.
2. Example:
   • If a tech company adopts efficient software development practices, it may reduce the average cost per unit of software.