Review of Chapter 6: The Cost of Production

Economic reasoning

1. Understand the relevancy to decision making of opportunity cost, sunk cost, fixed
cost and variable cost.
2. Know the relevant cost relationships involving: SMC and AVC, SAC (or,
similarly, you can try to analyze LMC and LAC).
3. Understand relationships between production and costs, especially between MP
and MC in the short run, returns to scale and LAC.
4. Shut down decision in the short run: R>VC (P>AVC).
5. Shut down decision in the long run: R>C (P>LAC).
6. Shut down decision for multiple products: Ri>VCi in the short run and total
profit>0 in the long run.
7. Is allocating fixed costs relevant in shut down decisions?

Graphical Skill:

1. Understand the shapes of the cost curves: AFC, AVC, SAC, SMC. Pay attention
to how the shapes of AVC and SAC depend on the shape of SMC.
2. Use graphs to help determine minSMC, minSAC, minAVC.
3. Returns to scale and the shape of LAC.

Problem Solving Skill:

1. Derive short run and long run cost functions given production functions and input
prices.
2. Derive AFC, AVC, SAC, SMC, LAC, LMC from cost functions.
3. Determine min AVC, minSAC, min SMC and minLAC.
4. Given a production function, determine returns to scale, and how LAC changes
with Q.
5. Shut down problem for a single product; multiple products.
6. Use appropriate costs for limited capacity decision making.