Economics Cost

7/31/2019 Economics Cost

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COST CONCEPTS


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Opportunity cost

Opportunity cost is the most

fundamental cost concept.

The opportunity cost of doing or getting

something is:

what you could have done or gotten

instead


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Opportunity cost is what you forgo.

Example: Your opportunity cost for

taking this course includes:

Whatever else you could have bought

with your tuition and fee money

plus

the work, family participation, and

recreation that you are not doing

because you are here.


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Money cost concepts

The cost-accounting concepts welldiscuss:

Total cost Fixed cost

Variable cost

Marginal cost Average cost


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Total cost

... is a function of quantity

function in the mathematical sense

Total cost = TC(Q)

TC(Q) = the total cost per unit of

time of producing Q units of output

per unit of time

TC = TVC + TFC


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Fixed Costs

Costs associated with owning a fixedinput or resource

Do not change as level of production

changes Fixed cost is the cost of producing

zero output in a given time period.

Not under control of the manager inthe short-run

Present in the short-run only


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Variable Cost

Variable cost equals total cost

minus fixed cost.

The variable cost is extra cost of

producing Q, above the cost of

producing 0.

Can be increased or decreased at

the managers discretion

In the "long run," all costs are

variable.


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Fixed Costs, Variable Costs,

and Total Costs

The sum of the variable and fixed

costs are total costs.TC = FC + VC


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Total Cost Curves

The total variable cost curve has the

same shape as the total cost

curveincreasing output increases

variable cost.


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Totalcost

$400

350

300

250

200

150

100

50

0

FC

2 4 6 8 10 20 30

Quantity of earrings

VC

TC

Total Cost Curves

TC =(VC + FC)


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Marginal Cost

Marginal costis the increase

(decrease) in total cost of increasing

(or decreasing) the level of output by

one unit.

In deciding how many units to

produce, the most important

variable is marginal cost.


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Marginal cost

Marginal cost is

Total cost at output Q

minus

total cost at output Q-1.

Marginal cost is the additional cost of

producing one more.

Or the reduction in cost from producingone less.


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Average Costs

Average total cost(often called

average cost) equals total cost

divided by the quantity produced.ATC = TC/Q


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Average Costs

Average fixed costequals fixed cost

divided by quantity produced.AFC = FC/Q


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Average Costs

Average variable costequals

variable cost divided by quantity

produced.AVC = VC/Q


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Average Costs

Average total cost can also be

thought of as the sum of average

fixed cost and average variable

cost.ATC = AFC + AVC


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Cost

$302826242220

18161412108

642

0

Quantity of earrings

2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32

Per Unit Output Cost Curves

AFC

AVCATC

MC


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Average cost & Marginal cost

Marginal cost is what to use to

decide whether to do something.

Average cost is good for telling you

whether you're making money

overall.

Profit = Revenue minus cost.

Average profit per unit =

Revenue Units Average Cost per

unit.


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Average and Marginal Cost

Curves

The marginal cost curve goes

through the minimum point of the

average total cost curve and

average variable cost curve.

Each of these curves is U-shaped.

The average fixed cost curve slopes

down continuously.


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Downward-Sloping Shape of

the Average Fixed Cost Curve

The average fixed cost curve starts

out with a steep decline, then it

becomes flatter and flatter.

It tells us that as output increases,

the same fixed cost can be spread

out over a wider range of output.


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The U Shape of the Average

and Marginal Cost Curves

When output is increased in the

short-run, it can only be done byincreasing the variable input.


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The law of diminishing marginal

productivity sets in as more and

more of a variable input is added toa fixed input.

Marginal and average

productivities fall and marginalcosts rise.


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And when average productivity of the

variable input falls, average variablecost rise.


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The average total cost curve is the

vertical summation of the average

fixed cost curve and the average

variable cost curve.


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If the firm increased output

enormously, the average variable cost

curve and the average total cost curvewould almost meet.

The firms eye is focused on

average total costit wants tokeep it low.


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Average and Marginal

Cost Curves

Output

$

MC ATC

AVC

AFC


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Relationship Between

Marginal and Average Costs

The marginal cost and average cost

curves are related.

When marginal cost exceeds average

cost, average cost must be rising.

When marginal cost is less than average

cost, average cost must be falling.


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Marginal cost curves always

intersect average cost curves at theminimum of the average cost

curve.


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The position of the marginal cost

relative to average total cost tellsus whether average total cost is

rising or falling.


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To summarize:If MC > ATC, then ATC is rising.

If MC = ATC, then ATC is at its lowpoint.

If MC < ATC, then ATC is falling.


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Marginal and average total cost

reflect a general relationship that

also holds for marginal cost andaverage variable cost.

If MC > AVC, then AVC is rising.

If MC = AVC, then AVC is at its lowpoint.

If MC < AVC, then AVC is falling.


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$90

80

70

60

50

40

30

20

10

0Quantity

Area B

Area A Area C

MC

ATC

AVC

1 2 3 4 5 6 7 8 9

Q1

B

AVC

ATC

MCQ0

A


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Long-run and short-run

In the short run, it pays to sell to any

customer who'll pay marginal cost.

Even if youre losing money overall,

you're losing less than if you had

turned down the sale.

In the long run, when you can get

out of your fixed cost, you shut

down if your average price is not

more than average cost.


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10.34

Long Run Costs

The long run average, LAC, andmarginal, LMC, cost curves have thesame basic shape that the

equivalent short run cost curves. However, the reason why each is U-

shaped is for different reasons,which are

Short run the Law of DiminishingMarginal returns

Long run economies/diseconomies

of scale


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Production costs in the long run

1.Types of costs:

TC; ATC; MC (ATC and MC: U shape)2. Economies of scale and diseconomies of

scale

Economies of scale: when increasing the

scale of production lead to a lower cost per

unit of output.

Q up----LAC down

Reasons: labor and managerialspecialization\ ability to purchase and use

more efficient capital goods\ other factors

such as advertising or other start up costs\

economy of bulk buying.


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Diseconomies of scale: where costs

per unit of output increase as thescale of production increases. Q up---

LAC down.

Reasons: the growing complexities ofmanaging a larger organization\

distant management, worker

alienation and problems with

communication and coordination..


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Short-Run & Long-Run Total

Cost Curves

The firms long-run total cost curve

consists of the lowest parts of the

short-run total cost curves. Thelong-run total cost curve is the

lower envelope of the short-run

total cost curves.


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The Envelope Relationship

In the short run all expansion mustproceed by increasing only the

variable input

This constraint increases cost

There is an envelope relationshipbetweenlong-run and short-run average total costs.Each short-run cost curve touches the long-run cost curve at only one point.

Long-run costs are always less than or equalto short-run costs because:

In the long run, all inputs are flexible

In the short run, some inputs are fixed

13-39


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The Envelope of

Short-Run Average Total Cost

Curves

SRMC3SRATC3

SRMC4

SRATC4

SRMC1SRATC

1

SRMC2SRATC2

LRATC

Q

Costsper unit

The long-run averagetotal cost curve (LRATC)

is an envelope of theshort-run average totalcost curves (SRATC1-4)

13-40


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LONG-RUN VERSUS SHORT-RUN COST CURVES

Long-Run Average Cost

Long-Run Average andMarginal Cost

When a firm is producing at anoutput at which the long-runaverage cost LAC is falling, thelong-run marginal cost LMC isless than LAC.Conversely, when LAC is

increasing, LMC is greater thanLAC.The two curves intersect at A,where the LAC curve achieves itsminimum.

h l i hi


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The Relationship Between

Productivity and Costs

The shapes of the cost curves

are mirror-image reflections of

the shapes of the corresponding

productivity curves.

Th R l i hi B


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When one is increasing, the other is

decreasing.

When one is at a maximum, theother is at a minimum.

Th R l i hi B


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Costsperunit

Productiv

ityofworkersatt

hisoutput

$18

16

1412

10

8

6

42

0 4 8 12 16 20 24

9

8

76

5

4

3

21

0 4 8 12 16 20 24

AVC

MC

Output Output

A

APofworkers

MPof workers




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Production Rules

Short-run

SP > ATC

Produce where MR=MC

ATC > SP > AVC

Making contribution to

FC

Produce where MR=MC SP < AVC

Do not produce

Long-run

SP > ATC

Produce whereMR=MC

SP < ATC

Do not produce


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Economics Cost

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