3.3.2 Costs — Practice Questions
Ten original multiple-choice questions on a firm's costs of production, written to the style and difficulty of Edexcel Paper 1 Section A.
Not read the notes yet? Start with the 3.3.2 Costs revision notes.
10 questions in this set
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1. A factory pays its production workers by the hour and its office manager an annual salary. In the classification of costs, the manager's salary is
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Answer: A (A fixed cost, as it does not vary with output.). The test is not what a cost buys but whether it changes with output. An annual salary is paid in full whether the factory runs flat out or produces nothing, so it is a fixed cost. Hourly wages rise and fall with hours worked, and hours worked rise and fall with output, so those are variable. Edexcel's page makes exactly this pairing — salaries beside rent as fixed, hourly wages beside raw materials as variable.
Why the other options are wrong
- B — Being paid to an employee is not the test. The hourly-paid production workers are employees too, and their wages are variable.
- C — Labour costs can be either. What decides it is whether the amount paid changes when output changes.
- D — Regularity is not the test either. A monthly rent is fixed and a monthly raw-materials bill is variable.
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2. A firm has total fixed costs of £480 a day. On a day when it produces 60 units its total variable costs are £660. Its average cost at that output is
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Answer: C (£19.00). Average cost is total cost divided by output, and total cost is fixed plus variable.
TC = £480 + £660 = £1,140.
AC = £1,140 ÷ 60 = £19.00.
It is worth checking this the other way round: AFC = £480 ÷ 60 = £8.00 and AVC = £660 ÷ 60 = £11.00, and £8.00 + £11.00 = £19.00. AC is always AFC plus AVC. As output rises AFC keeps falling, since the same £480 is spread more thinly, while AVC eventually rises — and that tension is what gives the short-run AC curve its U shape.Why the other options are wrong
- A — £8.00 is average fixed cost. It is one of the two components of average cost, not the whole of it.
- B — £11.00 is average variable cost — the other component.
- D — £1,140 is total cost. Average cost requires dividing it by the 60 units produced.
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3. Producing 25 units costs a workshop £700 in total. Producing 30 units costs it £850. Over that range, each additional unit adds
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Answer: C (£30.00). This is marginal cost — the change in total cost divided by the change in output.
Change in total cost: £850 − £700 = £150.
Change in output: 30 − 25 = 5 units.
MC = £150 ÷ 5 = £30.00.
Marginal cost here is above average cost at either output — £28.00 at 25 units and £28.33 at 30. That is why average cost is rising across this range: every extra unit costs more than the running average, so it drags the average up.Why the other options are wrong
- A — £28.00 is average cost at 25 units, £700 ÷ 25.
- B — £28.33 is average cost at 30 units, £850 ÷ 30. The two averages sit close together, which is what makes them tempting — but neither is the cost of an extra unit.
- D — £150 is the total increase in cost. It has to be spread across the five extra units, not attributed to one.
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4. Table 1 shows one firm's total cost at four levels of output.
From Table 1, average cost is at its lowest at an output ofTable 1: One firm's total cost at four levels of output Output Total cost 20 £560 40 £920 60 £1,260 80 £1,760 Show model answer
Answer: C (60 units). Divide total cost by output at each row:
20 units: £560 ÷ 20 = £28.00
40 units: £920 ÷ 40 = £23.00
60 units: £1,260 ÷ 60 = £21.00
80 units: £1,760 ÷ 80 = £22.00
The lowest is £21.00 at 60 units. Watch what marginal cost does around it: the 20 units before that point add £340, or £17 each, which is below average cost and pulls it down; the next 20 add £500, or £25 each, which is above average cost and pushes it back up. Average cost turns upward exactly where marginal cost rises above it.Why the other options are wrong
- A — £28.00 is the highest average cost in the table, because the fixed costs are spread over so few units.
- B — £23.00 is lower, but average cost is still falling at that point — 60 units is cheaper still.
- D — The trap: the largest output is not the cheapest per unit. By 80 units average cost has already turned back up, to £22.00.
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5. A firm's rent rises sharply. Its output, its wage rate and the price of its materials are all unchanged. Its marginal cost curve will
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Answer: A (Be unaffected, since rent is a fixed cost.). Marginal cost is the change in total cost from producing one more unit. Total cost is fixed cost plus variable cost, and fixed cost by definition does not change with output — so the change in total cost is entirely the change in variable cost. A higher rent raises total cost and raises average cost at every output, but it adds nothing whatever to the cost of the next unit. This is why a firm facing a rent rise does not change its output in the short run: MC = MR still holds in the same place.
Why the other options are wrong
- B — Nothing in the stem reduces any cost, so no curve moves downwards.
- C — This confuses marginal cost with average cost. Average cost does shift up at every output, by exactly the rise in average fixed cost — but marginal cost does not.
- D — The slope of MC comes from diminishing returns to the variable factor, and the stem leaves the variable factors untouched.
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6. The long-run average cost curve is described as an envelope of the short-run average cost curves. What this means is that the LRAC curve
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Answer: D (Traces the lowest cost achievable at each output.). Each SRAC curve shows what costs look like at one scale of production — one size of factory, one quantity of capital. In the long run the firm can pick any scale it likes, so at every level of output it uses whichever scale produces that output most cheaply. The LRAC curve is the result: the lower boundary formed by all the short-run curves together, tracing the cheapest way of producing each output. That is what an envelope means. Edexcel's page adds that LRAC is flatter than the individual SRAC curves, because in the long run every input can be adjusted rather than one being stuck.
Why the other options are wrong
- A — LRAC lies below or on each short-run curve, never above it. Being free to vary every input cannot leave a firm worse off than being stuck with a fixed one.
- B — It is a lower boundary, not an average. Averaging would place it above the cheapest short-run curve at every output, which would mean the firm never chose the best scale.
- C — LRAC does turn upward eventually, but not wherever the short-run curves do. Each SRAC rises once its own scale is pushed beyond its efficient range — and in the long run the firm escapes that by moving to a larger scale instead.
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7. In the short run a firm's average cost curve falls and then rises. The reason it eventually turns upward is that
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Answer: B (Diminishing returns push marginal cost upward.). In the short run at least one factor — usually capital — is fixed. Adding more of the variable factor to it raises output by more and more at first, as specialisation takes hold, and then by less and less, because the fixed factor becomes a constraint. Edexcel's example is a pub with a fixed number of bar counters: past a point, extra bartenders simply get in each other's way. Falling marginal product means rising marginal cost, and once MC climbs above AC it drags the average up. That is the upward arm of the U.
Why the other options are wrong
- A — Average fixed cost falls continuously as output rises, since the same fixed sum is spread over more units. It works against the upturn rather than causing it.
- C — The minimum efficient scale belongs to the long-run curve, where every factor can be varied. This is a short-run curve.
- D — Fixed costs do not change with output. That is what makes them fixed.
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8. Diminishing returns and diseconomies of scale both raise a firm's costs. They differ in that diminishing returns
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Answer: D (Apply in the short run and raise marginal cost.). The two are separated by the time period and by which curve moves. Diminishing returns are a short-run effect: they arise from adding a variable factor to a fixed one, and they push marginal cost up, which is what makes the short-run MC and AC curves U-shaped. Diseconomies of scale are a long-run effect: they arise once every factor has been increased together, and they push long-run average cost up, which is what makes LRAC U-shaped. Edexcel gives a practical test — a firm described as building a bigger plant or expanding its scale is a question about diseconomies.
Why the other options are wrong
- A — This describes diseconomies of scale, not diminishing returns.
- B — Wrong on both counts. Nothing in the long run is fixed for a variable factor to be added to, so diminishing returns cannot operate there.
- C — The time period is right but the curve is wrong. Diminishing returns raise short-run marginal cost; they have no effect on the long-run average cost curve.
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9. A firm producing 250 units has total costs of £6,000, of which £2,500 are fixed. Its average variable cost is
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Answer: B (£14.00). Variable cost is whatever is left of total cost once the fixed element is removed.
TVC = £6,000 − £2,500 = £3,500.
AVC = £3,500 ÷ 250 = £14.00.
Check it against the other two averages: AFC = £2,500 ÷ 250 = £10.00 and AC = £6,000 ÷ 250 = £24.00. AFC + AVC = £10.00 + £14.00 = £24.00 = AC, as it has to be.Why the other options are wrong
- A — £10.00 is average fixed cost. It is the part the question asks you to strip out.
- C — £24.00 is average total cost, which still contains the fixed element.
- D — £3,500 is total variable cost. The question asks for it per unit.
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10. A firm signs a ten-year lease on its premises. Judged over a two-year horizon the rent is a fixed cost. Judged over a fifteen-year horizon it is
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Answer: C (A variable cost, since the premises can change.). Fixed and variable are defined by the time horizon, not by the type of cost. In the short run at least one factor cannot be changed — here the firm is tied to its lease, so the rent is paid whatever it produces. Over a horizon long enough for the lease to end, the firm can take a larger site, a smaller one, or none at all, so the rent becomes something it chooses in the light of the scale it wants. This is why Edexcel states that in the long run all costs are variable, and why there is a long-run average cost curve but no long-run average fixed cost curve.
Why the other options are wrong
- A — The sum payable under this particular lease does not change, but the firm is no longer committed to paying it once the lease can be ended. That is precisely what makes it variable in the long run.
- B — Marginal cost is the cost of producing one more unit. It is not a third category alongside fixed and variable.
- D — Every cost is one or the other. Which one it is depends entirely on the time horizon being considered.