Cost Theory: Fixed/Variable Costs, Average/Marginal Costs, LRAC, SRAC, Economies and Diseconomies of Scale

1. Fixed cost is best defined as a cost that

A changes directly with output in the short run
B does not change with output in the short run
C is always zero when output is zero
D rises only when price rises

2. Variable cost is best defined as a cost that

A changes with output
B remains unchanged at all output levels
C is always paid even when output is zero
D is the same as sunk cost

3. Which is most likely to be a fixed cost for a factory in the short run?

A raw materials
B hourly wages of temporary production workers
C rent of factory building
D packaging per unit

4. Which is most likely to be a variable cost?

A insurance premium on factory building
B rent of office premises
C raw materials used in production
D annual licence fee

5. Total cost is calculated as

A fixed cost + variable cost
B total revenue – output
C average cost × price
D marginal cost – average cost

6. Average fixed cost is calculated as

A fixed cost / output
B variable cost / output
C total cost / fixed cost
D output / fixed cost

7. Average variable cost is calculated as

A total variable cost / output
B total fixed cost / output
C total cost / price
D marginal cost / output

8. Average total cost is calculated as

A total cost / output
B total revenue / output
C total product / labour
D total cost – total revenue

9. Marginal cost is

A cost of producing one extra unit of output
B total cost divided by output
C fixed cost divided by output
D total revenue minus total cost

10. If fixed cost is $500, variable cost is $1200 and output is 100 units, average total cost is

A $5
B $12
C $17
D $1700

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

11. If total cost rises from $5000 to $5400 when output rises from 100 to 120 units, marginal cost per extra unit is

A $20
B $40
C $400
D $5400

12. If fixed cost is $800 and output is 40 units, average fixed cost is

A $20
B $40
C $760
D $840

13. If total cost is $3000, fixed cost is $1000 and output is 200 units, average variable cost is

A $5
B $10
C $15
D $20

14. If output rises and fixed cost is unchanged, average fixed cost

A rises continuously
B falls continuously
C stays constant
D becomes total variable cost

15. Which statement about marginal cost is correct?

A MC is always equal to average cost
B MC cuts AC at AC’s minimum point
C MC cuts AC at AC’s maximum point
D MC is always below AVC

16. If marginal cost is below average cost, average cost will

A rise
B fall
C remain unchanged
D become negative

17. If marginal cost is above average cost, average cost will

A rise
B fall
C remain unchanged
D equal fixed cost

18. Average cost is at its minimum when

A MC = AC
B MC = AVC only
C fixed cost = zero
D total cost = total revenue

19. Average variable cost is at its minimum when

A MC = AVC
B MC = AC
C AFC = AVC
D TC = TVC

20. If marginal cost is rising but still below average cost, average cost is

A rising
B falling
C constant
D zero

21. If marginal cost is falling, average cost must

A always rise
B always fall
C fall if MC is below AC
D rise if MC is below AC

22. A firm’s total cost schedule is:

Output: 0, 1, 2, 3, 4
Total cost: 100, 160, 210, 270, 350

What is fixed cost?

A 0
B 100
C 160
D 350

23. Using the same schedule, what is marginal cost of the 4th unit?

A 60
B 70
C 80
D 350

24. Using the same schedule, what is average total cost at 4 units?

A 62.5
B 80
C 87.5
D 350

25. Using the same schedule, what is average variable cost at 3 units?

A 56.7
B 90
C 170
D 270

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

26. Short-run average cost curves are usually U-shaped mainly because

A fixed costs rise as output rises
B marginal returns first increase then diminish
C all factors are variable
D average fixed cost rises continuously

27. Long-run average cost is U-shaped mainly because of

A economies of scale followed by diseconomies of scale
B diminishing marginal utility
C fixed costs remaining unchanged forever
D demand first rising then falling

28. The long run is the period in which

A all factors of production are variable
B all costs are fixed
C no firm can change scale
D output must be constant

29. The short run is the period in which

A all factors are variable
B at least one factor is fixed
C no costs exist
D average cost must be falling

30. Economies of scale occur when

A average cost falls as output/scale increases
B total cost falls as output rises
C marginal cost is always zero
D price falls because demand falls

31. Diseconomies of scale occur when

A average cost rises as scale increases
B average cost falls as scale increases
C total cost is zero
D output falls because price rises

32. Internal economies of scale arise from

A growth of the individual firm
B growth of the whole industry only
C fall in national income
D government reducing all taxes

33. External economies of scale arise from

A growth of the whole industry or region
B a single firm buying more inputs only
C one firm hiring a specialist manager
D one firm spreading advertising cost

34. Which is an internal economy of scale?

A bulk-buying discounts from suppliers
B better roads built because an industry expands in an area
C specialist training colleges created for an industry
D skilled labour attracted to a region due to industry growth

35. Which is an external economy of scale?

A a firm spreads advertising cost over more output
B a firm uses specialist machinery
C a supplier network develops near a growing industry
D a firm gains financial discounts due to its size

36. Technical economies of scale are most likely from

A use of larger, more efficient machinery
B borrowing at lower interest rates
C buying raw materials in bulk
D hiring specialist marketing staff

37. Financial economies of scale occur when large firms

A borrow at lower interest rates
B use larger machinery
C divide labour into specialist tasks only
D face higher communication costs

38. Managerial economies of scale occur when

A firms employ specialist managers
B firms face poor coordination
C workers become bored
D suppliers raise prices

39. Marketing economies of scale occur when

A advertising costs are spread over larger output
B managers lose control of workers
C production becomes overcrowded
D marginal product becomes negative

40. Purchasing economies of scale occur when

A large firms buy inputs in bulk at lower unit cost
B large firms face diseconomies from bureaucracy
C firms produce less output
D consumers demand fewer goods

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

41. Diseconomies of scale may be caused by

A poor communication and coordination in large firms
B bulk-buying discounts
C specialist machinery
D spreading fixed costs over more output

42. Which is most likely to shift a firm’s LRAC curve downwards?

A external economies of scale
B external diseconomies of scale
C rising wage rates in the whole industry
D congestion around industrial areas

43. Which is most likely to shift a firm’s LRAC curve upwards?

A external diseconomies of scale
B improved industry infrastructure
C growth of specialist suppliers
D better local training facilities

44. A firm doubles all inputs and output more than doubles. What happens to long-run average cost?

A falls
B rises
C remains unchanged
D becomes fixed cost only

45. A firm doubles all inputs and output less than doubles. What happens to long-run average cost?

A falls
B rises
C remains unchanged
D becomes zero

46. A firm doubles all inputs and output exactly doubles. What happens to long-run average cost?

A falls
B rises
C remains unchanged
D becomes marginal cost

47. Minimum efficient scale is

A the lowest level of output at which long-run average cost is minimised
B the output where total cost is zero
C the output where marginal utility is zero
D the highest output before total revenue falls

48. A natural monopoly is most likely when

A LRAC falls over the full range of market demand
B LRAC rises immediately at low output
C many small firms can produce at lower average cost than one large firm
D fixed costs are zero and marginal costs are very high

49. If a firm’s long-run average cost curve is still falling at the level of market demand, this suggests

A one large firm may supply the market more cheaply than many small firms
B perfect competition is guaranteed
C diseconomies of scale dominate
D output should be divided equally among many firms

50. Which chain is most accurate?

A larger scale → purchasing/technical/managerial economies → lower LRAC → possible lower prices or higher profit
B larger scale → fixed cost rises with every unit → AFC rises → economies of scale
C external economies → LRAC shifts upward → output becomes impossible
D diseconomies of scale → average cost falls → productive efficiency guaranteed

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

1. Answer: B

A wrong: a cost that changes directly with output is variable cost.
B correct: fixed cost does not change with output in the short run.
C wrong: fixed cost exists even when output is zero.
D wrong: fixed cost is not determined by product price.

2. Answer: A

A correct: variable cost changes as output changes.
B wrong: unchanged cost is fixed cost.
C wrong: costs paid even at zero output are fixed costs.
D wrong: sunk cost is a past unrecoverable cost.

3. Answer: C

A wrong: raw materials vary with output.
B wrong: temporary production wages usually vary with output.
C correct: rent of the factory building usually stays fixed in the short run.
D wrong: packaging per unit varies with output.

4. Answer: C

A wrong: insurance premium is usually fixed in the short run.
B wrong: rent is usually fixed in the short run.
C correct: raw materials increase as output increases.
D wrong: annual licence fee is usually fixed.

5. Answer: A

A correct: total cost = total fixed cost + total variable cost.
B wrong: total revenue – output has no cost meaning.
C wrong: average cost × output, not price, gives total cost.
D wrong: marginal cost – average cost is not total cost.

6. Answer: A

A correct: average fixed cost = fixed cost / output.
B wrong: variable cost / output gives AVC.
C wrong: total cost / fixed cost is not AFC.
D wrong: output / fixed cost reverses the formula.

7. Answer: A

A correct: AVC = total variable cost / output.
B wrong: total fixed cost / output gives AFC.
C wrong: total cost / price is not AVC.
D wrong: marginal cost / output is not AVC.

8. Answer: A

A correct: average total cost = total cost / output.
B wrong: total revenue / output gives average revenue.
C wrong: total product / labour gives average product.
D wrong: total cost – total revenue gives loss/profit calculation, not ATC.

9. Answer: A

A correct: marginal cost is the extra cost of producing one more unit.
B wrong: total cost / output gives average cost.
C wrong: fixed cost / output gives average fixed cost.
D wrong: total revenue – total cost gives profit.

10. Answer: C

A wrong: $5 is AFC = 500/100.
B wrong: $12 is AVC = 1200/100.
C correct: total cost = 500 + 1200 = 1700; ATC = 1700/100 = $17.
D wrong: $1700 is total cost, not average cost.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

11. Answer: A

A correct: marginal cost = change in TC / change in output = 400/20 = $20.
B wrong: $40 incorrectly divides by 10 units.
C wrong: $400 is total cost increase, not per-unit MC.
D wrong: $5400 is new total cost.

12. Answer: A

A correct: AFC = 800/40 = $20.
B wrong: $40 would imply fixed cost of $1600.
C wrong: $760 subtracts output from fixed cost.
D wrong: $840 adds output to fixed cost.

13. Answer: B

A wrong: $5 is fixed cost per unit.
B correct: TVC = 3000 – 1000 = 2000; AVC = 2000/200 = $10.
C wrong: $15 is average total cost.
D wrong: $20 is not supported.

14. Answer: B

A wrong: AFC does not rise as output rises.
B correct: fixed cost is spread over more units, so AFC falls continuously.
C wrong: AFC changes as output changes.
D wrong: AFC does not become total variable cost.

15. Answer: B

A wrong: MC is not always equal to AC.
B correct: MC cuts AC at AC’s minimum point.
C wrong: AC has a minimum, not a relevant maximum here.
D wrong: MC can be above or below AVC.

16. Answer: B

A wrong: AC rises when MC is above AC.
B correct: when MC is below AC, it pulls average cost down.
C wrong: AC remains unchanged only when MC = AC.
D wrong: AC does not become negative.

17. Answer: A

A correct: when MC is above AC, it pulls average cost up.
B wrong: AC falls when MC is below AC.
C wrong: AC changes unless MC = AC.
D wrong: average cost does not equal fixed cost.

18. Answer: A

A correct: average cost is minimised where MC = AC.
B wrong: MC = AVC gives minimum AVC, not minimum AC.
C wrong: fixed cost does not need to be zero.
D wrong: total cost = total revenue means normal profit/break-even, not AC minimum.

19. Answer: A

A correct: AVC is minimised where MC = AVC.
B wrong: MC = AC gives minimum average total cost.
C wrong: AFC = AVC has no general minimum rule.
D wrong: TC = TVC only if fixed cost is zero.

20. Answer: B

A wrong: AC rises only when MC is above AC.
B correct: if MC is still below AC, AC falls, even if MC itself is rising.
C wrong: AC is constant only when MC = AC.
D wrong: AC is not zero.

21. Answer: C

A wrong: falling MC does not automatically make AC rise.
B wrong: AC does not always fall unless MC is below AC.
C correct: AC falls when MC is below AC.
D wrong: if MC is below AC, AC falls, not rises.

22. Answer: B

A wrong: fixed cost is not zero because total cost at zero output is $100.
B correct: fixed cost equals total cost when output is zero, so FC = $100.
C wrong: $160 is total cost at 1 unit.
D wrong: $350 is total cost at 4 units.

23. Answer: C

A wrong: 60 is the marginal cost of the 3rd unit.
B wrong: 70 is not the change from 3 to 4 units.
C correct: MC of 4th unit = TC4 – TC3 = 350 – 270 = $80.
D wrong: $350 is total cost at 4 units.

24. Answer: C

A wrong: $62.5 is not TC/output.
B wrong: $80 is marginal cost of the 4th unit.
C correct: ATC at 4 units = 350/4 = $87.5.
D wrong: $350 is total cost.

25. Answer: A

A correct: TVC at 3 units = TC – FC = 270 – 100 = 170; AVC = 170/3 = $56.7.
B wrong: $90 is TC/3, average total cost.
C wrong: $170 is total variable cost, not average variable cost.
D wrong: $270 is total cost.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

26. Answer: B

A wrong: fixed costs do not rise with output in the short run.
B correct: SRAC is U-shaped because marginal returns first increase, lowering costs, then diminish, raising costs.
C wrong: all factors variable describes the long run.
D wrong: AFC falls continuously.

27. Answer: A

A correct: LRAC falls due to economies of scale, then rises due to diseconomies of scale.
B wrong: diminishing marginal utility is consumer theory.
C wrong: there are no fixed factors in the long run.
D wrong: demand movement does not directly explain LRAC shape.

28. Answer: A

A correct: long run means all factors of production are variable.
B wrong: all costs are not fixed in the long run.
C wrong: firms can change scale in the long run.
D wrong: output does not have to be constant.

29. Answer: B

A wrong: all factors variable describes the long run.
B correct: short run means at least one factor is fixed.
C wrong: costs exist in the short run.
D wrong: average cost may rise or fall.

30. Answer: A

A correct: economies of scale occur when LRAC/average cost falls as scale increases.
B wrong: total cost usually rises as output rises, even if average cost falls.
C wrong: marginal cost is not always zero.
D wrong: demand falling is not economies of scale.

31. Answer: A

A correct: diseconomies of scale occur when average cost rises as scale increases.
B wrong: falling average cost means economies of scale.
C wrong: total cost is not zero.
D wrong: price changes are not the definition.

32. Answer: A

A correct: internal economies come from the growth of one firm itself.
B wrong: whole industry growth creates external economies.
C wrong: national income is unrelated.
D wrong: tax cuts are not internal economies of scale.

33. Answer: A

A correct: external economies arise from industry/regional growth benefiting firms.
B wrong: one firm buying more inputs is internal purchasing economy.
C wrong: hiring a specialist manager is internal managerial economy.
D wrong: spreading advertising cost is internal marketing economy.

34. Answer: A

A correct: bulk-buying discounts are internal purchasing economies from firm growth.
B wrong: better industry roads are external economies.
C wrong: training colleges for an industry are external economies.
D wrong: skilled labour attracted to a region is an external economy.

35. Answer: C

A wrong: spreading advertising cost is internal marketing economy.
B wrong: specialist machinery is internal technical economy.
C correct: a supplier network developing near a growing industry benefits firms externally.
D wrong: financial discounts from firm size are internal financial economies.

36. Answer: A

A correct: technical economies come from using larger, more efficient machinery or production methods.
B wrong: lower borrowing rates are financial economies.
C wrong: bulk buying is purchasing economy.
D wrong: specialist marketing staff are managerial/marketing economies.

37. Answer: A

A correct: large firms may borrow at lower interest rates because lenders see them as less risky.
B wrong: machinery relates to technical economies.
C wrong: division of labour relates to technical/managerial economies.
D wrong: communication problems are diseconomies.

38. Answer: A

A correct: managerial economies occur when larger firms employ specialist managers.
B wrong: poor coordination is diseconomy of scale.
C wrong: boredom is more linked to division of labour problems.
D wrong: supplier price rises are not managerial economies.

39. Answer: A

A correct: marketing economies occur when advertising and promotion costs are spread over more output.
B wrong: loss of control is diseconomy.
C wrong: overcrowding is short-run diminishing returns.
D wrong: negative marginal product is production theory.

40. Answer: A

A correct: purchasing economies occur when larger firms buy in bulk at lower unit cost.
B wrong: bureaucracy is diseconomy.
C wrong: lower output does not create purchasing economies.
D wrong: consumer demand is not the cause.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.

41. Answer: A

A correct: large firms may face communication delays, coordination problems and bureaucracy, raising average cost.
B wrong: bulk buying is an economy of scale.
C wrong: specialist machinery is an economy of scale.
D wrong: spreading fixed costs lowers average cost.

42. Answer: A

A correct: external economies reduce costs for all firms in an industry, shifting LRAC downward.
B wrong: external diseconomies shift LRAC upward.
C wrong: rising industry wages increase costs.
D wrong: congestion raises costs.

43. Answer: A

A correct: external diseconomies raise costs for firms, shifting LRAC upward.
B wrong: improved infrastructure lowers costs.
C wrong: specialist suppliers lower costs.
D wrong: training facilities improve productivity and reduce costs.

44. Answer: A

A correct: output more than doubling when inputs double means increasing returns to scale, so LRAC falls.
B wrong: LRAC rises with decreasing returns to scale.
C wrong: LRAC unchanged occurs with constant returns to scale.
D wrong: LRAC does not become fixed cost.

45. Answer: B

A wrong: LRAC falls when output increases more than proportionately.
B correct: output less than doubles while inputs double, so average cost rises.
C wrong: unchanged LRAC requires output to double exactly.
D wrong: LRAC does not become zero.

46. Answer: C

A wrong: LRAC falls if output more than doubles.
B wrong: LRAC rises if output less than doubles.
C correct: doubling inputs and output means constant returns to scale, so LRAC remains unchanged.
D wrong: LRAC does not become marginal cost.

47. Answer: A

A correct: minimum efficient scale is the lowest output where LRAC reaches its minimum.
B wrong: total cost is not zero.
C wrong: marginal utility is consumer theory.
D wrong: total revenue is revenue theory.

48. Answer: A

A correct: natural monopoly occurs when LRAC keeps falling across market demand, so one firm can supply more cheaply than many.
B wrong: rising LRAC at low output would not favour one large firm.
C wrong: this would support competition, not natural monopoly.
D wrong: natural monopoly usually has high fixed costs and low marginal costs.

49. Answer: A

A correct: falling LRAC at market demand means larger scale is cheaper, so one large firm may be most efficient.
B wrong: perfect competition is unlikely when one large firm has cost advantage.
C wrong: diseconomies would make LRAC rise.
D wrong: splitting output among many firms may raise average cost.

50. Answer: A

A correct: larger scale can create purchasing, technical and managerial economies, lowering LRAC and allowing lower prices or higher profit.
B wrong: fixed cost does not rise with every unit; AFC usually falls as output rises.
C wrong: external economies shift LRAC downward, not upward.
D wrong: diseconomies raise average cost, so productive efficiency is not guaranteed.

Written and Compiled By Sir Hunain Zia (AYLOTI), World Record Holder With 154 Total A Grades, 11 World Records and 7 Distinctions, Educate A Change.