EC4004 Lecture10: Costs
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Transcript of EC4004 Lecture10: Costs
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EC4004 Lecture 10: CostsDr. S. Kinsella
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Dates: October 17th -24th
Best of 2 attempts
10% of Final Grade
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Yesterday
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Production Function
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Marginal Products
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Diminishing Marginal Productivity
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Isoquants
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Marginal Rate of Technical substitution
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Today: Returns to Scale; Costs
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Constant Returns to Scale
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Capitalper week
4
A
321
Laborper week1 2 3
(a) Constant Returns to Scale
40q = 10
q = 20
q = 30q = 40
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Decreasing Returns to Scale
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Capitalper week
4
A
321
Laborper week1 2 3
(a) Constant Returns to Scale
40
Capitalper week
4
A
321
Laborper week1 2 3
(b) Decreasing Returns to Scale
40q = 10 q = 10
q = 20q = 20q = 30
q = 30q = 40
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Increasing Returns to Scale
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Capitalper week
K2
A
q2
q1
q0
K1
K0
Laborper weekL0 L1 L2
0
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Capitalper week
K1
A
q’0
q0
K0
Laborper weekL1 L00
Technical Change
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Opportunity cost: cost of a good as measured by the alternative uses foregone by producing good or service.Accounting cost: concept that goods or services cost what was paid for them.Economic cost: amount required to keep a resource in its present use; the amount that it would be worth in its next best alternative use.
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Labour Costs
Wage, w
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The cost of capital services (machine-hours) is the rental rate (v) which is the cost of hiring one machine for one hour.
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Economic profit is revenue minus all costs including these entrepreneurial costs.
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Total costs = TC = wL + vK. (8.1)Assuming the firm produces only one output, total revenue equals the price of the product (P) times its total output [q = f(K,L) where f(K,L) is the firm’s production function].
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Economic profits (π): Difference between a firm’s total
revenues and its total economic costs.
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Capitalper week
TC1TC2
TC3
q1
K*
Laborper weekL*0
Minimizing the Costs of Producing q1
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Cost minimization requires that the marginal rate of technical substitution (RTS) of L for K equals the ratio of the inputs’ costs, w/v:
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The firm’s expansion path is the set of cost-minimizing input combinations a firm will choose to produce various levels of output (when the prices of inputs are held constant).
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Capitalper week
TC1 TC3TC2 Expansion path
q1
q2
q3K1
Laborper weekL10
Firm’s Expansion Path
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Cost Curves
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Totalcost
TC
Quantityper week
(a) Constant Returns to Scale
0
Totalcost
TC
Quantityper week
(b) Decreasing Returns to Scale
0
Totalcost TC
Quantityper week
(c) Increasing Returns to Scale0
Totalcost
TC
Quantityper week
(d) Optimal Scale
0
Possible Shapes of the Total Cost Curve
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Average Costs
Average cost is total cost divided by output; a common measure of cost per unit.If the total cost of producing 25 units is €100, the average cost would be:
AC = €100/25 = €4
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Marginal Cost
The additional cost of producing one more unit of output is marginal cost.If the cost of producing 24 units is €98 and the cost of producing 25 units is €100, the marginal cost of the 25th unit is €2.
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AC, MC
AC, MC
Quantityper week
(a) Constant Returns to Scale
0
AC, MCAC
AC
AC
MC
MC
MC
Quantityper week
(b) Decreasing Returns to Scale
0
AC, MC
Quantityper week
(c) Increasing Returns to Scale0
AC, MC
Quantityper week
(d) Optimal Scale
0 q*
Average and Marginal Cost Curves
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Shifts in Cost CurvesAny change in economic conditions that affects the expansion path will also affect the shape and position of the firm’s cost curves.Three sources of such change are:change in input pricestechnological innovations, andeconomies of scope.
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Next Time
Production & Supply
Chapter 9, Do Ex. 81, 8.3, 8.7
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EC4004 Lecture 10: CostsDr. S. Kinsella