Firms which have to fill in paperwork and complicated tax returns will have higher costs. Higher national insurance (tax on workers) raises costs. Nearly all firms will be affected by higher oil prices – which increase the cost of transport. oil, plastic, and metal – will increase the cost of firms. A rise in the cost of raw materials, e.g. If the firm needs to import raw materials, an appreciation can reduce the cost of production (though exports will be less competitive) A rise in the exchange rate makes imports cheaper. New technology which improves output per worker enables the firm to cut back on employing workers, leading to lower costs. For labour intensive industry (service sector/manufacturing of clothes) a small change in wage costs has a big impact on the overall costs of firms. Diseconomies of scale occur when increased output leads to higher long-run average costs.Economies of scale occur when increased output, leads to lower long-run average costs.However, as the amount of capital can vary, the firm may experience economies or diseconomies of scale.
Therefore, the firm will not face diminishing returns. In the long run, a firm can vary all factors of production, such as capital and labour. See: Diminishing returns to scale Long Run Costs This means as firms employ more workers, there will come a point where extra workers have a declining marginal product.Īs productivity (and marginal product) falls, the marginal cost of production will increase. However, in the short term, a firm is likely to experience diminishing marginal returns. In the short run, the firm can vary the quantity of labour. In the short run, a firm will have fixed capital (it takes time to increase the size of factories). But, as output increases, they may take on more workers or pay overtime. For example, a firm may continue to employ workers, even during a slump in production. Some costs may exhibit both fixed and variable factors. For example, as you produce more cars, you will have to pay for more raw materials, such as metal, tyres and plastic.Īverage variable costs (AVC) = VC/Q Semi-Variable costs As output increases, there will be more variable costs. These are costs that do vary with output. As more goods are produced, the average costs will fall. For example, if a new factory costs £1 million, this cost is unaffected by the number of goods produced.Īverage fixed costs (AFC) = FC/Q. However many goods are produced, fixed costs will remain constant. These are costs that do not vary with output. Long-run costs (potential economies and diseconomies of scale.Short-run costs (subject to diminishing returns).Marginal Cost: This is the cost of producing an extra unit.Semi-variable costs – costs like labour which to some extent depend on output.Variable costs – costs relating to how much is produced (e.g.Sunk costs – costs that cannot be recovered on leaving industry, e.g.Fixed costs – costs that don’t vary with output.Costs of production relate to the different expenses that a firm faces in producing a good or service.
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