1. Managerial Economics Eighth Edition Truett + Truett
Chapter 6: Cost of Production
John Wiley & Sons, Inc.
11/17/2018
Slides by Jim Witsmeer

2. Session Outline Types of Costs ($) Costs in the Long Run
Total
Average
Marginal
Interrelationships
Costs in the Short Run
Fixed
Variable
Total
Average
Marginal
Comparison with
Long Run
Interrelationships
Cost Elasticity
Cost Estimation
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3. Discussion of Costs ($)
Social costs
Private costs
Implicit or opportunity costs
Historical or explicit costs
Fixed costs (do not vary with output quantity)
Variable costs (vary with output quantity)
Semi-variable costs (can divide into fixed & variable)
Incremental costs (added cost due to action)
Why are all costs considered variable in the long run?
Should social costs be considered in business decisions?
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4. Long-Run Total Cost (LTC)
Input b L K
Long-Run Total Cost is the least cost combination of inputs for each production quantity (AKA, the expansion path)
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5. Long-Run Average & Marginal Cost (LAC & LMC)
Long-Run Average Cost $ Q
Arc LMC
LMC
Long-Run Marginal Cost
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6. Relationship of LTC, LAC and LMC
Long-Run Marginal Cost (LMC) is minimum when the rate of increase of Long-Run Total Cost is smallest.
Long-Run Marginal Cost (LMC) equals Long-Run Average Cost (LAC) when Long-Run Average Cost (LAC) is at its minimum
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7. Numerical Example
Step through long-run cost numerical example in the textbook
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8. Short-Run Total Cost (STC)
In the short run we have fixed costs in addition to variable costs.
Short-Run Total Cost (STC) equals Total Fixed Cost (TFC) plus Total Variable Cost (TVC).
TFC does not change with production output.
TVC increases as quantity produced is increased.
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9. Short-Run Average & Marginal Cost (SAC & SMC)
Average Fixed Cost is Total fixed Cost divided by production output.
Similarly Average Variable Cost is:
Short–Run Average Total Cost:
Short-Run Marginal Cost is: or
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10. Comparing Long and Short Run Costs
On the Long-Run Total Cost curve every point represents a least-cost combination.
On the Short-Run Total Cost curve one or more inputs are fixed so that only a single point can be a least-cost combination of inputs.
The STC curves intersect the cost axis at the value of the Total Fixed Cost (TFC).
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11. Relationship of (STC, TVC, TFC, SMC, SAC, AVC, AFC & SAC)
TVC = PLL
TFC= PKK
STC
The minimum short-run marginal cost occurs where TFC and TVC have the least slope.
Minimum average variable cost occurs when AVC = SMC.
Minimum short-run average cost occurs when SAC = SMC.
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12. Relationship of Average Product of L and Average Variable Cost (AVC)
If the average productivity of the variable input increases there will be a corresponding drop in the average variable cost.
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13. Relationship of Marginal Product of L and Short-Run Marginal Cost
Q L
Arc MPL
Arc SMCL $
If the marginal productivity of the variable input increases there will be a corresponding drop in the short-run marginal cost.
Similarly using calculus
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14. Relationship of Short-Run to Long-Run Average Costs
In the long run all total costs represent least-costs.
Therefore all average costs must be least cost as well.
There are various short-run cost curves for various values of the fixed input.
In the short run only one point represents least cost.
The optimum operating point in the short run (minimum SAC) is normally higher than the least cost in the long run.
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15. Cost Elasticity Cost Elasticity: Percentage change in LTC
Percentage change in Q
Cost Elasticity: or
Economies of scale correspond to Increasing Returns to Scale
Diseconomies of scale correspond to Decreasing Returns to Scale
Economies
of scale or
Diseconomies of scale or
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16. Is the LAC Curve Continuous and Stable?
NO,it has discrete changes (see Figure 6-15 in text) because:
Not all combinations of inputs are practical
Processes make discrete jumps
NO, it can change because of:
Introduction of new technology
The learning curve
Economies of scope
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17. Choosing the Optimal Plant Size
How many plants should we have?
One large plant gains possible economies of scale.
Many plants reduce transportation costs.
One large plant is more vulnerable to labor disputes.
One large plant is more vulnerable to acts of God.
Many plants increase political representation.
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18. Estimating Costs
Similar to estimating demand but generally more accurate.
Estimating methods include:
Regression analysis using linear and other specialized functions
General forecasting methods
Product specialized forecasting methods
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19. End of Chapter 6
Copyright © 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the United States copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for resale. The publisher assumes no responsibilities for errors, omissions, or damages, caused by the use of the information contained herein.
11/17/2018