Costs

Measuring costs Explicit: actual payment Implicit: foregone opportunities Opportunity cost: value of next best alternative Capital costs (durable goods): rental cost Historical costs (dont matter any more) Sunk costs: expenditures already made (or contractually committed to) Short-run costs Cannot vary capital As a result: more costly to increase output in the SR than LR Fixed costs (F): dont vary with output Variable costs (VC): change with Q produced (L, materials)

Total cost: C = VC + F. Marginal cost: MC = C/q (or MC = C/q). Also, MC = VC/q Average cost: AFC = F/q ( as Q , spread over more units) AVC = VC/q AC (or ATC): AC = C/q = AFC + AVC

R/ships between curves: AC is slope of line from 0 to TC AVC is slope of line from 0 to TVC MC is slope of AC or AVC at that q AC = MC at AC min. When MC < AC, AC is falling; for MC > AC, AC rises. MC = AVC at AVC min.

Production function determines shape of cost curves. Remember DMR to L VC = wL Long-run costs Firms will adjust inputs that were fixed in the SR so its cost of production is low Fixed costs are avoidable (not sunk as in SR) C = VC. (TC, AC & MC only.) Firm must choose the tech efficient K, L combination that also costs the least (economic efficiency).

Isocost line: Shows all combinations of inputs that require the same total expenditure. Cost of Q depends on prices of L & K: Labour cost = wL Capital cost = rK (r & w constant) e.g. w = $5, r = $10 per hour combins that cost $100 $100 isocost line. C= wL + rK

K = C/r (w/r)L e.g. K = = 100/10 (5/10)L 10 L

Intercepts: C/r, C/w. Further from 0 = higher costs. Slope = -w/r (for whole family).

Combining cost & production:

Use any of 3 rules: Lowest isocost rule - pick the bundle of inputs where the lowest isocost line touches the isoquant. Tangency rule - pick the bundle of inputs where the isoquant is tangent to the isocost line. Last-dollar rule - last $ spent on 1 input adds as much to output as last $ spent on other input/s. Slopes of IQ & isocost are =, i.e. MRTS = -w/r Also, MRTS = -MPL MPK MPL = w MPK r MPK r

So at tangency

Rearrange: MPL = w

(At y, too much K relative to L: MPL > w

MPK r

Lower costs in the LR The firm plans in the LR but operates in the SR. LRAC as the envelope of SRAC e.g. firm can choose one of 3 plant sizes: Small Medium

Large

SRACs 1-3 correspond to S, M, L plants. Best size depends on output level LR, firm will choose plant size that has lowest AC for each Q level. LRAC is defined by the min AC of each level of Q (envelope curve). Most firms can choose from many poss sizes (not just 3) Allowing continuous variation in size gives a smooth LRAC curve. LRAC = key planning tool.

SR & LR expansion paths:

Start at x. SR: K = 100; for q=200, L & move to y (costs $4616). LR: z is more cost efficient ($4000). Flexibility in input mix lowers LR costs. LR expansion path upward sloping SR expansion path horizontal LR: increase K & L by 2 times to double output SR: K is constant & L can only be increased as a result costs are higher in the SR 2,3 times cost to double output

Costs of producing multiple goods Economies of scope: costs less to produce goods together than separately. SC = C (q1,0) + C (0, q2) C (q1, q2) C (q1, q2)

SC = 0 : same together/separately SC = + : produce together economies of scope SC = - : produced separately diseconomies of scope