Cost Concepts in Economics Chapter 9

Cost Classification Fixed or variable Cash or non-cash Accounting expense or not Opportunity costs

Opportunity Costs Not an accounting expense Every input has an alternative use OC is the value of product not produced because input was used for another purpose OC is income that would have been received if input had been used in its most profitable alternative use

Opportunity Costs Not an accounting expense Every input has an alternative use OC is the value of product not produced because input was used for another purpose OC is income that would have been received if input had been used in its most profitable alternative use

Short-run and Long-run Costs Short-run = time period when one or more inputs are fixed Long-run = time period when all inputs can be changed (none are fixed)

Fixed Costs Costs associated with owning a fixed input or resource Do not change as level of production changes Incurred even if not input is used Not under control of the manager in the short-run Present in the short-run only

DIRTI 5 Depreciation =

DIRTI 5 Depreciation = Interest =

DIRTI 5 Depreciation = Interest = Repairs Taxes Insurance

DITI 4 Depreciation = Interest = Taxes Insurance

Example of Fixed Costs Purchase a pickup for $20,000 Salvage value of $5,000 Useful life of 5 years Interest rate of 10% Taxes are $25 / year Insurance is $1,000 / year

Variable Costs Those costs that the manager has control over in a given period of time Can be increased or decreased at the manager’s discretion Feed, seed, fertilizer, etc

Total and Average Costs Total costs = TVC + TFC Average Variable Costs (AVC) =TVC / Output level Average Fixed Costs (AFC) =TFC / Output level Average Total Costs (ATC) =TC / Output level =AVC + AFC

Marginal Costs Cost associated with a change in the output What did it cost for the last unit of increased output? MC =

Typical Total Cost Curves TVC TC TFC Output $

Average and Marginal Cost Curves Output $ MC ATC AVC AFC

Stocking Rate ProblemTFC = $4000 VC = $395 / steerSelling price = $70 / cwt

Production Rules Short-run SP > ATC Produce where MR=MC ATC > SP > AVC Making contribution to FC Produce where MR=MC SP < AVC Do not produce Long-run SP > ATC Produce where MR=MC SP < ATC Do not produce

Cost Concepts in Economics Summary Cost Classification Opportunity costs Fixed, Variable, and Marginal costs DITI 4 Average total, fixed, and variable costs Marginal costs Cost Curves Production rules

Cost Concepts in Economics Questions?