Costs 10-1

Drawing on Chapter 10 Original graphics & text copyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Outline Costs in the short run Allocating production between two processes The relationship among MP, AP, MC, and AVC Costs in the long run Long-run costs and the structure of industry The relationship between long-run and short-run cost curves 10-3

Costs In The Short Run Suppose Output Q=F(K,L) K the fixed input L the variable input Their respective prices r and w Then Fixed cost: FC = rK0 Variable cost (VC): VCQ = wL Total cost: TC = FC+VCQ = rK0+wL 10-4

Figure 10.1: Output as a Function of One Variable Input 10-5

Figure 10.2: The Total, Variable, and Fixed Cost Curves 10-6

Figure 10.3: The Production Function Q = 3KL, with K = 4 10-7

Figure 10.4: The Total, Variable, and Fixed Cost Curves for the Production Function Q-3KL 10-8

Unit Costs In The Short Run Average costs Average fixed cost: 𝑨𝑭𝑪 𝑸 = 𝑭𝑪 𝑸 Average variable cost: 𝑨𝑽𝑪 𝑸 = 𝑽𝑪 𝑸 𝑸 Average total cost: 𝑨𝑻𝑪 𝑸 = 𝑻𝑪 𝑸 𝑸 = 𝑨𝑭𝑪 𝑸 + 𝑨𝑽𝑪 𝑸 Marginal cost 𝑴𝑪 𝑸 = ∆ 𝑽𝑪 𝑸 ∆𝑸 = ∆ 𝑻𝑪 𝑸 ∆𝑸 10-9

Figure 10.5: The Marginal, Average Total, Average Variable, and Average Fixed Cost Curves 10-10

Figure 10.6: Quantity vs. Average Costs 10-11

Figure 10.7: Cost Curves for a Specific Production Process 10-12

Figure 10.8: The Minimum Cost Production Allocation Among Processes 10-13

Figure 10.9: The Relationship Between MP, AP, MC, and AVC 10-14

Costs In The Long Run Let C measure the cost of production. We assume that each firm minimizes its cost, C, of producing a given amount of output, say Q0. Why is this reasonable? An isocost line shows the set of input bundles with a given cost, say C0. 10-15

Figure 10.10: The Isocost Line 10-16

Figure 10.11: The Maximum Output for a Given Expenditure 10-17

Figure 10.12: The Minimum Cost for a Given Level of Output 10-18

Figure 10.13: Different Ways of Producing 1 Ton of Gravel 10-19

The Relationship Between Optimal Input Choice And Long-run Costs How do costs (total, average, and marginal) change across possible output levels for a particular production process? The output expansion path traces out minimum cost input combinations in the isoquant map with isocost lines of given slope and increasing cost and output. 10-20

Figure 10.15: The Long-Run Expansion Path 10-21

Figure 10.16: The Long-Run Total, Average, and Marginal Cost Curves 10-22

The Relationship Between Optimal Input Choice And Long-run Costs With _____ returns to scale, as output grows, inputs and LR total cost grow _____ proportionally, so LR average and marginal cost are _____. Constant exactly constant Decreasing more than increasing Increasing less than decreasing 10-23

Figure 10.17: The LTC, LMC and LAC Curves with Constant Returns to Scale 10-24

Figure 10.18: The LTC, LAC and LMC Curves for a Production Process with Decreasing Returns to Scale 10-25

Figure 10.19: The LTC, LAC and LMC Curves for a Production Process with Increasing Returns to Scale 10-26

Long-run Costs And The Structure Of Industry The number of firms in an industry depends on the minimum efficient scale of production: the minimum output level at which LAC is minimized. Natural monopoly: an industry whose market output is produced at the lowest cost when production is concentrated in the hands of a single firm. 10-27

Figure 10.20: LAC Curves Characteristic of Highly Concentrated Industrial Structures 10-28

Figure 10.21: LAC Curves Characteristic of Unconcentrated Industry Structures 10-29

Figure 10.22: The Family of Cost Curves Associated with a U-Shaped LAC 10-30