Economics Unit 3 Business Economics and Economic Efficiency

Cost Curves Homework

1. What is the difference between fixed and variable costs? (AO1)

marks

Fixed costs are costs which do not vary with the level of output of a firm, for
example rent. Variable costs are costs which change as the level of output
changes, for example raw materials.
2. Identify the impact of the following on marginal and average cost use
diagrams to answer your question:
a. A rise in rent paid by a manufacturer on its factory. (AO2) 2 marks
The marginal cost is the cost of producing each additional unit of output.
The marginal cost is not affected by the rent, as rent is a fixed cost. This
means the average cost decreases, as average cost is made up of fixed
cost and variable cost, and fixed cost does not change.

b. A reduction in factory worker wages. (AO2)

2 marks
Wages are a variable cost, so the marginal cost is affected. A reduction in
wages will reduce the costs for firms, which reduces marginal cost. The
average cost is also decreased, as average cost is made of variable and
fixed costs.

3. Explain the concept of diminishing marginal returns and the impact it has
on marginal cost. (AO3)
4 marks
The law of diminishing marginal returns states that in the short run, as one factor
of production is increased while all others stay constant, the marginal output of

each additional factor of production will be less than the previous factor of
production.
The law of diminishing marginal returns means that the marginal cost will
increase as there will be a reduction of output per additional unit input. This
reduction in efficiency illustrates the diminishing marginal returns.