Presentation on theme: "Learning Objectives Delineate the nature of a firm’s cost – explicit as well as implicit. Outline how cost is likely to vary with output in the short run."— Presentation transcript:
1 Learning ObjectivesDelineate the nature of a firm’s cost – explicit as well as implicit.Outline how cost is likely to vary with output in the short run and various measures of short-run cost.Detail the typical shapes of a firm’s short-run cost curves.See how a firm will choose to combine inputs in its production process in the long run when all inputs are variable.Show how input price changes affect a firm’s cost curves.(Continued)
2 Learning Objectives (continued) Differentiate between a firm’s long-run and short-run cost curves.Understand how the minimum efficient scale of production is related to market structure.Cover economies of scope – is it cheaper for one firm to produce products jointly than it is for separate firms to produce the same products independently?Overview how cost functions can be empirically estimated through surveys and regression analysis.
3 The Nature of Cost Recall: Explicit costs – arise from transactions in which the firm purchases inputs or the services of inputs from other partiesImplicit costs – costs associated with the use of the firm’s own resources and reflect the fact that these resources could be employed elsewhereOpportunity cost reflects both explicit and implicit costs.
4 Measures of Short-Run Cost Total fixed cost (TFC) – the cost incurred by the firm that does not depend on how much output it producesTotal variable cost (TVC) – the cost incurred by the firm that depends on how much output it produces
5 Five Other Measure of Short-Run Cost Total cost (TC) – the sum of total fixed and total variable cost at each output levelMarginal cost (MC) – the change in total cost that results from a one-unit change in outputAverage fixed cost (AFC) – total fixed cost divided by the amount of outputAverage variable cost (AVC) – total variable cost divided by the amount of outputAverage total cost (ATC) – total cost divided by the output
9 Marginal CostThe marginal product curve of the variable input generally rises and then falls, attributable to the law of diminishing marginal returns.As a result, the MC curve will first fall and then rise.
10 Average CostThe average product curve rises, reaches a maximum, and then falls, due to the law of diminishing marginal productivity.As a result, the AVC curve will fall and then rise.The AFC curve declines over the entire range of output as the amount of total fixed cost is spread over ever-larger rates of output.The ATC curve is the sum of AFC and AVC. It measures the average unit cost of all inputs, both fixed and variable, and must also be U-shaped.
11 Marginal-Average Relationships When marginal cost is below average (total or variable) cost, average cost will decline.When marginal cost is above average cost, average cost rises.When average cost is at a minimum, marginal cost is equal to average cost.
13 Isocost LinesAn isocost line is a line that identifies all the combinations of capital and labor, two factor inputs, that can be purchased at a given total cost.The line intersects each axis at the quantity of that input that the firm could purchase if only that input were purchased.The slope of an isocost line is (minus) the ratio of input prices, w/r, indicating the relative prices of inputs.
14 Least Costly Input Combination A point of tangency between an isocost line and an isoquant show the least costly way of producing a given output level.Alternatively, a point of tangency shows the maximum output attainable at a given cost as well as the minimum cost necessary to produce that output.
15 Interpreting the Tangency Points Golden rule of cost minimization: a rule that says that to minimize cost, the firm should employ inputs in such a way that the marginal product per dollar spent is equal across all inputsMPL/w = MPK/r
16 If the firm is not producing at a tangency point… Whenever MPL/w > MPK/r, a firm can increase output without increasing production cost by shifting outlays from capital to labor.Whenever MPL/w < MPK/r, a firm can increase output without increasing production cost by shifting outlays from labor to capital.
17 The Expansion PathThe expansion path is a curve formed by connecting the points of tangency between isocost lines and the highest respective attainable isoquants.
19 Input Price Changes and Cost Curves Increase in the cost of land
20 Long-Run Cost Curves [Figure 8.7] Note Figure 8.6 in book
21 Economies of Scale and Diseconomies of Scale Economies of scale – a situation in which a firm can increase its output more than proportionally to its total input costDiseconomies of scale – a situation in which a firm’s output increases less than proportionally to its total input cost
22 Learning by DoingLearning by doing – improvements in productivity resulting from a firm’s cumulative output experienceVersus economies of scale
23 Economies of Scope and Diseconomies of Scope Economies of scope – a case where it is cheaper for one firm to produce products jointly than it is for separate firms to produce the same products independentlyDiseconomies of scope – a case where it is cheaper for separate products to be produced independently than for one firm to produce the same products jointlyTC (R,T) < [TC(R,0) + TC(0,T)]
24 Estimating Cost Functions Techniques:SurveysEconometric specificationNew entrant/survivor technique – method for determining the minimum efficient scale of production in an industry based on investigating the plant sizes either being built or used by firms in the industry