Beruflich Dokumente
Kultur Dokumente
Chapter 8
Introduction
Classifications of costs Implicit or explicit fixed or variable Develop family of cost curves long run (all factors variable) short run (all factors except one fixed) Cost minimization problem Use isoquants from production theory, set tangent to isocost line (input price ratio) Cost curves incorporate technology used for producing an output input prices given (supply is perfectly elastic, firms are price takers)
long-run cost curves and returns to scale How do cost curves shift when input prices change or new technologies are introduced.
Owners of firm also have an implicit cost associated with time devoted to a particular production activity
Variable
Costs associated with variable inputs and do vary with output
Note: Explicit and implicit costs may contain both fixed and variable costs
Variable
Explicit: electricity to run machine, cans for beer. Implicit: Opp. cost of time owner spends overseeing workers.
Fixed
Explicit: long term lease on machinery Implicit: Opp. cost of not selling a new technology invented for production
Profits
Normal
Minimum total return to the inputs necessary to keep a firm in a given production activity
Also called necessary, ordinary, or opportunity-cost profit
Pure
Total return above total cost Also called economic profit In short run, possibility of earning a pure profit exists but firms will only earn a normal profit in long run
In long run, firms have ability to enter or exit an industry
Will not operate at a loss or earn a pure profit
Cost Minimization
Cost Function: A mathematical relationship showing the lowest economic cost for each possible level of output. Cost minimization is done by constrained optimization:
Identify lowest cost mix of inputs to achieve a given level of output Two inputs are used in production Perfectly competitive input and output markets
Firm takes input and output prices as fixed
Input supply curves are horizontal and perfectly elastic
Cost Minimization
q ! K
1/ 2
L1 / 2
where w0 = fixed wage r0 = fixed cap. cost
q0 ! K
1/ 2
L1 / 2
L ! w0L r0K P q0 K
1/ 2
L1 / 2
(2) (3)
w q 0 r
0
L!0
1/ 2
r0 L* ! 0 q 0 w
0 1/ 2 1/ 2
Optimal Level of L, L*
w0 w r0 K * ! 0 0 q0 ! 0 q0 r r w
Optimal Level of K, K*
r 0 0 w TC ! w 0 q r 0 w r
0 * 0
1/ 2
q0
0 1/ 2
1/ 2
TC ! w
*
r
0 1/ 2
0 1/ 2
q w
r
0 1/ 2
q0
TC * ! 2( w0 r 0 )1/ 2 q 0
1/ 2
1/ 2
0 1/ 2
1/ 2
Tangency
6 4
FK w ! EL r
4 La o
Constructing LRTC
Vary Level of Output and connect tangency points along long-run expansion path
LRTC for CRS Cobb Douglas Example
4
LR C
6 4
Output
LRTC
r 0 L ! 0 q w
0 *
1/ 2
w 0 K ! 0 q r
*
0 1/ 2
Can determine L*, K* combinations for any level of output by varying q =>
r L ! 0 q w
0 * 1/ 2
1/ 2
w K ! 0 q r
* 1/ 2
0 1/ 2
r L ! q w
*
w K ! q r
*
LRATC LRMC
Output
LRATC = LRMC
RMC
Output
!$
!"
"
"
where z =
!"
q( K,
)=
zq(K,
)= q
&
RA C
Output
&
O tp t
q( K,
)=
zq(K,
)< q
6 4
10
'0
98 1)
4 R RM RM R 4 O tp t 6 7
Output
q( K,
)=
zq(K,
)> q
R RM
FG
@G
P H I
R
FA
@A
FE
@E
LMC LAC
Marginal cost differs from average cost by per-unit effect on costs of higher output, multiplied by total output
If LAC does not vary with output adjustment factor is zero
Short-run Costs
Short run => One of the inputs is fixed
Example: Upon signing a 5-year lease for their restaurant, owners have committed themselves to paying a fixed amount in costs whether they operate or not Results in a short-run situation where, for short-run profit maximization, owners will determine lowest TC for a given level of output and fixed input
Lowest TC is called short-run total cost (STC)
STC= short-run total variable cost (STVC) + total fixed cost (TFC)
Assuming that capital is fixed at K in short run STC(K) = STVC(K) + TFC(K) = min(wL + vk)
(wL + vk) is isocost equation STVC(K) = wL* and TFC(K) = vk
L* denotes level of labor that minimizes costs for a given level of output
Even if firm were to produce nothing, in short run it must still pay TFC
TFC is a horizontal line, showing that at all output levels, TFC remains the same
Note: SRMC should Pass through the Minimum of SAVC & SATC
q ! K
1/ 2
L1 / 2
where w0 = fixed wage r0 = fixed cap. Cost K0 = fixed capital
! K
0 0
0 1/ 2
L1 / 2
L ! w Lr K
0
P q K
0
0 1/ 2
L1 / 2
(2)
q 0
dL 0 0 1/ 2 1/ 2 K ! q
L ! 0 L ! 0 K dP
2L w
1/ 2 0 0
= dTC/dq SRMC =
K
0 2 0
0 1/ 2
2w K
L K
K
0 1/ 2 0 1/ 2
0
1/ 2
0 1/ 2
2 w0 q ! K0
q0 2w* 0 K wq rK 0 0 K q
q
r K
*
SMC = dSRTC/dq =
SVC =
q
K0
0 2
SATC = SRTC/q =
Example:
5000 0000 35000 30000 SRTC 25000 20000 15000 10000 5000 0 0 100 200 300 Output 00 500 00 00 120 100 0 SRMC 1 0
w0 = 5; r0 = 20; K0 =50
SRTC
Properties of SR Cost Functions SRMC is increasing with Output SRAVC will eventually rise SRATC is U shaped.
0 0 20
SRAC
00
500
00
00
SATC is sum of SAVC and AFC SATC is U-shaped due to Law of Diminishing Marginal Returns Short-run marginal cost (SMC) for a fixed level of capital K is defined as
A positively sloping SMC represents diminishing marginal returns A negatively sloping SMC represents increasing marginal returns Shape of SMC is determined by Law of Diminishing Marginal Returns
As output increases SMC curve will have a positive slope at some point
SR vs. LR
In general, there are an infinite number of short-run total cost curves One for every conceivable level of fixed input LRTC = Envelope of all these SR cost-minimizing choices STC curves for alternative levels of fixed input capital completely cover top of LTC curve and will not dip below it STC will only equal LTC at output level where long-run optimal input usage of capital corresponds to fixed capital input level associated with STC
Where STC is tangent to LTC, SATC is also tangent to LAC SATC curves envelop top of LAC curve SATC cannot be less than LAC for a given level of output
Price changes?
Increase in wages? w0 -> w Shifts isocost line to left Shifts expansion path to left Raises LTC
Technology Change?