Download - EC4004 Lecture 10: Costs
EC4004 Lecture 10: CostsDr. S. Kinsella
Dates: October 17th -24th
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Yesterday
Production Function
Marginal Products
Diminishing Marginal Productivity
Isoquants
Marginal Rate of Technical substitution
Today: Returns to Scale; Costs
Constant Returns to Scale
Capitalper week
4
A
321
Laborper week1 2 3
(a) Constant Returns to Scale
40q = 10
q = 20
q = 30q = 40
Decreasing Returns to Scale
Capitalper week
4
A
321
Laborper week1 2 3
(a) Constant Returns to Scale
40
Capitalper week
4
A
321
Laborper week1 2 3
(b) Decreasing Returns to Scale
40q = 10 q = 10
q = 20q = 20q = 30
q = 30q = 40
Increasing Returns to Scale
Capitalper week
K2
A
q2
q1
q0
K1
K0
Laborper weekL0 L1 L2
0
Capitalper week
K1
A
q’0
q0
K0
Laborper weekL1 L00
Technical Change
Opportunity cost: cost of a good as measured by the alternative uses foregone by producing good or service.Accounting cost: concept that goods or services cost what was paid for them.Economic cost: amount required to keep a resource in its present use; the amount that it would be worth in its next best alternative use.
Labour Costs
Wage, w
The cost of capital services (machine-hours) is the rental rate (v) which is the cost of hiring one machine for one hour.
Economic profit is revenue minus all costs including these entrepreneurial costs.
Total costs = TC = wL + vK. (8.1)Assuming the firm produces only one output, total revenue equals the price of the product (P) times its total output [q = f(K,L) where f(K,L) is the firm’s production function].
Economic profits (π): Difference between a firm’s total
revenues and its total economic costs.
Capitalper week
TC1TC2
TC3
q1
K*
Laborper weekL*0
Minimizing the Costs of Producing q1
Cost minimization requires that the marginal rate of technical substitution (RTS) of L for K equals the ratio of the inputs’ costs, w/v:
The firm’s expansion path is the set of cost-minimizing input combinations a firm will choose to produce various levels of output (when the prices of inputs are held constant).
Capitalper week
TC1 TC3TC2 Expansion path
q1
q2
q3K1
Laborper weekL10
Firm’s Expansion Path
Cost Curves
Totalcost
TC
Quantityper week
(a) Constant Returns to Scale
0
Totalcost
TC
Quantityper week
(b) Decreasing Returns to Scale
0
Totalcost TC
Quantityper week
(c) Increasing Returns to Scale0
Totalcost
TC
Quantityper week
(d) Optimal Scale
0
Possible Shapes of the Total Cost Curve
Average Costs
Average cost is total cost divided by output; a common measure of cost per unit.If the total cost of producing 25 units is €100, the average cost would be:
AC = €100/25 = €4
Marginal Cost
The additional cost of producing one more unit of output is marginal cost.If the cost of producing 24 units is €98 and the cost of producing 25 units is €100, the marginal cost of the 25th unit is €2.
AC, MC
AC, MC
Quantityper week
(a) Constant Returns to Scale
0
AC, MCAC
AC
AC
MC
MC
MC
Quantityper week
(b) Decreasing Returns to Scale
0
AC, MC
Quantityper week
(c) Increasing Returns to Scale0
AC, MC
Quantityper week
(d) Optimal Scale
0 q*
Average and Marginal Cost Curves
Shifts in Cost CurvesAny change in economic conditions that affects the expansion path will also affect the shape and position of the firm’s cost curves.Three sources of such change are:change in input pricestechnological innovations, andeconomies of scope.
Next Time
Production & Supply
Chapter 9, Do Ex. 81, 8.3, 8.7
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EC4004 Lecture 10: CostsDr. S. Kinsella