"Chapter 6: Costs"
Chapter 6: Costs I. Concepts of Costs a. Accounting Cost b. Economic Costs (Opportunity cost) c. Application i. Labor 1. Cost of wages and benefits accepted as the cost of labor 2. Labor has a cost even when it is not paid ii. Capital 1. Rental rate of a machine is often used as the cost of a machine iii. Entrepreneurial costs 1. Included as profits in accounting systems 2. Included as a cost in economic systems II. Cost Minimization a. Profit is total revenue minus total cost b. Total cost is cost of the inputs TC = wL + vK – cost of labor plus the cost of capital c. Problem is to minimize the cost of producing some quantity of a good d. Minimize TC = wL + vK subject to Q = f(L,K) e. Graphically – Figure 6.1, page 176 f. Table – Fit table for Bill’s lawn Service g. Algebra – MPL/MPk = w/v h. Rearranged – MPL/w = MPk/v – equalize the output per dollar of the input i For 2 interchangeable inputs table such as that for Bill Lawn Service j. For more than 2 interchangeable inputs use linear programming to find optimal solution. III. Cost Curves a. Total Cost – curve with total cost as a function of input prices and quantity of output b. Figure 6.3.d – production function experiences increasing then decreasing returns to scale c. AC = TC/Q d. MC = dTC/dQ e. If TC = $1,000 + .046Q.6 AC = 1000/Q + .046Q-.4 MC = .0276Q-.4 f. Shape of the Average Cost and Marginal Cost Curves – Figure 6.4 IV. Short Run Total Cost a. Short Run – period of time in which some inputs are fixed. b. Fixed inputs generate fixed costs c. By definition, fixed inputs can’t be changed in the short run d. Often the cost minimizing combination of inputs can’t be achieved i. Figure 6.7 e. Often production processes must be run inefficiently f. Picking the right size for a fixed input is a common occurrence in life. V. Relationship between short run and long run costs. a. Figure 6.9 VI. Shifts in Cost Curves a. Change in input prices i. Rotate total cost line ii. Result in shift of cost curves iii. Result in input substitution if possible b. Technical Innovation i. Shifts the production function and the isoquant ii. Lowers the cost curves iii. Result in input substitution