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1、A Level Model Answer: Theory of the FirmIn production, a distinction is made between short-run cost curves and long-run cost curves. Using appropriate cost curve diagrams, explain this distinction. (12 marks)The costs that a firm incurs can be separated into fixed costs and variable costs, which tog
2、ether make up a firms total costs. Fixed costs remain constant regardless of quantity output for example, the rent paid on a factory used when producing a good. Variable costs change as output increases or decreases. An example is the wage cost of labour. To produce more output, the firm hires more
3、labour, and has increased wage costs. The more variable inputs a firm uses, the greater the total variable costs.In microeconomics, the short-run refers to the period of time in which at least one factor of production (usually land, labour and/or capital) is fixed. For example, the time it takes for
4、 a contract with a property owner to end before the firm can move to a different location. Figure 1 Short-run cost curvesIn Figure 1, the AFC curve indicates that average fixed cost falls continuously as output increases, because it represents the amount of total fixed costs divided by an ever growi
5、ng quantity of output. The average variable cost, average total cost and marginal cost curves, although different from one other, all follow the same general pattern: at first they fall, reach a minimum, and then they begin to rise.Marginal cost rises with the amount of output produced, reflecting t
6、he property of diminishing marginal product as units of one input are added (with other inputs held constant) a point will be reached where the resulting additions to output will begin to decrease (marginal product will decline). Consider the limited size of the factory discussed earlier we can keep
7、 adding more and more variable inputs (such as labour) but, constrained by the limited space, we will eventually see no further increases in output and output may even start to fall due to overcrowding of the fixed factor(s). Thus the cost of producing an additional cost continues to rise even thoug
8、h the firm may be gaining no benefit in terms of increased output.In the long-run, all factors of production become variable in the example given, the firm can move to a bigger or less expensive factory. Because many costs are fixed in the short run but variable in the long run, a firms long-run cos
9、t curves differ from its short-run cost curves. As the firm plans its future activities in the long run, it can select any size or scale of operation depending on the quantity of output it is aiming for. The particular size it selects will be the one that minimises costs for that level of output. Th
10、e long-run average total curve is the curve that is tangent to each of the short-run cost curves. Long run average total costs represent the lowest possible average cost, or cost per unit of output, for every level of output, when all resources are variable.Figure 2 Long-run average total cost curve
11、sThe U-shape of the long-run ATC curve is a result of economies and diseconomies of scale. Economies of scale refer to the benefits in terms of falling average total cost gained from large scale production, occurring for a number of reasons. Firstly, as the scale of production increases, more worker
12、s must be employed, allowing for greater labour specialisation. As each worker specialises in a narrower range of tasks that make use of existing skills, and develop skills through repetition, worker efficiency is increased, allowing output to be produced at a lower average cost.Larger scales of pro
13、duction allow for more managers to be employed, each of whom can be specialised in a particular area, again resulting in greater efficiency and lower average cost.Large machines are often more efficient than smaller ones. However, a small firm with a small volume of output cannot make effective use
14、of large machines, and so is forced to use smaller, less efficient ones. Some machines are only available in large sizes that require large volumes of output in order to be used effectively. Some production processes, such as mass production assembly lines, require large volumes of inputs and output
15、 in order to be used efficiently. Costs of certain activities such as advertising, design, research and development result in lower average costs if they can be spread over large volumes of output.However, as a firm increases its scale of production, costs per unit of output may eventually start to
16、increase. As a firm grows, management faces co-ordination difficulties. Communication and decision-making will be slower. Staff may feel alienated in a large organisation and unless they are monitored effectively, the quality and output of their work may decline.Evaluate the view that productive and allocative efficiency is more likely to be achieved in perfectly competitive industries than monopolies. 13 marksProductive eff
