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Definition of Cost There are two types of cost associated with economic analysis
Opportunity cost is the value that is forgone in choosing one activity over the next best alternative Out-of-pocket cost is actual transfer of value that occur
Definition of Cost There are two types of cost associated with time
Incremental cost varies with the range of options available in the decision making process. Sunk cost does not vary with decision options.
SR Relationship Between Production and Cost A firms cost structure is related to its production process.
Costs are determined by the production technology and input prices.
Assuming that the firm is a price taker in the input market.
Keat/Young
SR Relationship Between Production and Cost Total variable cost (TVC) is associated with the variable input
Assume w=$500 per unit (pricetaker)
Total Input (L) 0 1 2 3 4 5 6 7 8 9 Q (TP) 0 1,000 3,000 6,000 8,000 9,000 9,500 9,850 10,000 9,850 MP 1,000 2,000 3,000 2,000 1,000 500 350 150 -150 TVC (wL) 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500
Keat/Young
SR Relationship Between Production and Cost TP and TVC are mirror images of each other
SR Relationship Between Production and Cost Total cost (TC) is the cost associated with all of the inputs. It is the sum of TVC and TFC.
TC=TFC+TVC
Marginal Costs Average Costs
Tool Set for Production Cost Analysis
vs.
Production Process Analysis
Keat/Young
SR Relationship Between Production and Cost Marginal cost (MC) is the change in total cost associated a change in output.
TC MC Q
Keat/Young
Keat/Young
TVC (wL) 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500
Keat/Young
The Short Run Cost Function Average total cost (ATC) is the average per-unit cost of using all of the firms inputs (TC/Q)
Average variable cost (AVC) is the average per-unit cost of using the firms variable inputs (TVC/Q) Average fixed cost (AFC) is the average per-unit cost of using the firms fixed inputs (TFC/Q)
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
Keat/Young
Keat/Young
Keat/Young
Keat/Young
The Short Run Cost Function Average total cost (ATC) is the average per-unit cost of using all of the firms inputs (TC/Q) At Q* - ATC is minimized or inputs are used most efficiently given the production function
Going at 55 MPH
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
Keat/Young
Irrational Exuberance
2003 Prentice Hall Business Publishing Managerial Economics, 4/e Keat/Young
The LR Relationship Between Production and Cost In the long run, all inputs are variable.
What makes up LRAC?
Keat/Young
The Long-Run Cost Function The LRAC is the lower envelope of all of the SRAC curves.
Minimum efficient scale is the lowest output level for which LRAC is minimized
Management efficiencies
Keat/Young
Keat/Young
The Learning Curve A downward slope in the learning curve indicates the presence of the learning curve effect
Why? Workers improve their productivity with practice
Keat/Young