Lectures in Microeconomics-Charles W. Upton Cost Function Basics

Production Isoquants Q1Q1 Q2Q2 Q3Q3 K L

Cost Function Basics Production Isoquants Q1Q1 Q2Q2 Q3Q3 K L Combinations of K and L giving equal (“iso”) quantities of output

Cost Function Basics Isocost Lines Q1Q1 Q2Q2 Q3Q3 K L

Cost Function Basics Isocost Lines Q1Q1 Q2Q2 Q3Q3 K L Combinations of K and L costing equal (“iso”) amounts

Cost Function Basics Isocost Lines Q1Q1 Q2Q2 Q3Q3 K L rK +wL = C 3 rK +wL = C 2 rK +wL = C 1

Cost Function Basics Optimal Points Q1Q1 Q2Q2 Q3Q3 K L A B C

Cost Function Basics The Expansion Line Q1Q1 Q2Q2 Q3Q3 K L

Cost Function Basics The Expansion Line Q1Q1 Q2Q2 Q3Q3 K L The combination of K and L that minimize the costs of different levels of output.

Cost Function Basics Our Basic Cost Function Cost is a function of output and factor prices C = C(q,r,w)

Cost Function Basics Our Basic Cost Function Cost is a function of output and factor prices C = C(q,r,w) We often simplify this to C = C(q)

Cost Function Basics Our Basic Cost Function Cost is a function of output and factor prices C = C(q,r,w) We often simplify this to C = C(q) A caution: we always assume we are finding the least cost way of producing q.

Cost Function Basics Other Measures of Cost Average Cost –Total Cost divided by quantity Marginal Cost –The incremental cost of another unit

Cost Function Basics Average Cost

Cost Function Basics Average Cost Increasing Average Cost Decreasing Average Cost Constant Average Cost Q Q Q $$$

Cost Function Basics Marginal Cost

Cost Function Basics Marginal Cost MC(q) = C(q) – C(q-1)

Cost Function Basics End ©2004 Charles W. Upton