1. 1 Part 3 ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Cost of Production Cost of Production Fixed and Variable Cost Fixed and Variable Cost Short-Run Cost Short-Run Cost Marginal Cost, Average Cost Marginal Cost, Average Cost Long-Run Cost Long-Run Cost Isocost Isocost Marginal Rate of Economic Substitution Marginal Rate of Economic Substitution Optimization Optimization Marginal Cost, Average Cost Marginal Cost, Average Cost Envelope Curve Envelope Curve

2. 2 Cost of Production ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Cost Accounting Cost Actual expenses plus depreciation charges for capital equipment Economic Cost Cost to a firm of utilizing economic resources in production, including opportunity cost Opportunity Cost Cost associated with opportunities that are foregone when a firm’s resources are not put to their highest-value use

3. 3 Cost of Production ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Cost Sunk Cost Expenditure that has been made and cannot be recovered Fixed and Variable Cost Fixed cost does not vary with the level of output (usually capital in short run period) Variable cost varies as output varies (usually labor) TC = FC+VC TC…total cost FC…fixed cost VC…variable cost

4. 4 Cost of Production ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example: A firm produces 100 000 units a year and sells them all for $5 each. The explicit costs of production are $350 000 and the opportunity costs of production are $100 000 A firm produces 100 000 units a year and sells them all for $5 each. The explicit costs of production are $350 000 and the opportunity costs of production are $100 000. What is the accounting and economic profit of the firm? Accounting profit: revenue-accounting costs 100 000*5-350 000= $150 000 100 000*5-350 000= $ 150 000 Economic profit: 100 000*5-350 000-100 000= $50 000 Economic profit: 100 000*5-350 000-100 000= $ 50 000

5. 5 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Marginal Cost is the additional cost for additional unit of output Marginal cost in short-run period

6. 6 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Average Total Cost is the cost per unit of output Average Fixed Cost Average Variable Cost

7. 7 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example: Example: Count total costs, average fixed costs, average variable costs, average total costs and marginal costs.

8. 8 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Solution: Graph the curves of AFC, AVC and AC into the same picture.

9. 9 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Solution: Solution: The curves of AFC, AVC and AC

10. 10 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union TC, MC, AC

11. 11 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Total Cost TC = w.L + r.K Unit cost of labor Unit cost of capital

12. 12 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Cost in short-run period Fixed capital

13. 13 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example :The table below contains a hypothetical firm’s total production data for cars during a certain period of time, Example : The table below contains a hypothetical firm’s total production data for cars during a certain period of time, r=300 CZK, w=50 CZK. Determine A)FC, if Q=15 cars B)TC, if Q=10 cars C)Does the table describe the short or the long run? L012 K10 Q0 15

14. 14 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Solution: a)FC (Q=15)= r*K= 300*10=3000 CZK b)TC (Q=10)= r*K+w*L=3000 + 50*1=3 050 CZK Short-run (fixed capital)

15. 15 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example: The curve of TC in short-run is described by TC=3 000 +30Q-12Q 2 +2Q 3. Determine: a)FC, if Q=1000 units b)FC, if Q=2000 units c)AFC, if Q=1000 units d)AFC, if Q=2000 units e)MC, if Q=3 units f)VC, if Q=10 units

16. 16 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Solution: The curve of TC in short-run is described by TC=3 000 +30Q-12Q 2 +2Q 3. a)FC (Q=1000)=3000 CZK b)FC (Q=2000)=3000 CZK c)AFC (Q=1000)=3000/1000=3 CZK d)AFC (Q=2000)=3000/2000=3/2 CZK e)MC (Q=3)=30-12*2Q+6Q 2 = 12 CZK f)VC (Q=10)= 30Q-12Q 2 +2Q 3 =1100 CZK

17. 17 Short-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Cost and Returns to Scale 1) Increasing Returns 2) Constant Returns 3) Decreasing Returns Cost is growing slower than production Cost is growing at the same rate as production Cost is growing faster than production

18. 18 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Cost in Long-Run Period All inputs are variable TC = w.L + r.K Unit cost of capital - interest rate and depreciation

19. 19 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Example: The curve of TC in long-run is described by TC=Q 2. Determine: a) TC, if Q=2 units b) MC, if Q=3 units Graph the curve of TC

20. 20 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Solution: The curve of TC in long-run is described by TC=Q 2. The curve of TC in long-run is described by TC=Q 2. a) TC (Q=2)= 2 2 =4 CZK (the parabole y=x 2 ) b) MC (Q=3)=2*Q=2*3=6 CZK

21. 21 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Isocost is a line showing all combinations of L & K that can be purchased for the same cost is a slope of the isocost line Marginal Rate of Economic Substitution

22. 22 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Optimization How to combine the inputs to get the lowest cost for the level of desired output or to get the highest output with given cost Point where the lowest isocost is touching the given isoquant or the given isocost is touching the highest isoquant

23. 23 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union Optimization

24. 24 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union LTC, LMC, LAC

25. 25 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union LTC, LMC, LAC Envelope Curve

26. 26 Long-Run Cost ___________________________________________________________________________ ___________________________________________________________________________ This project is co-financed by the European Union LTC, LMC, LAC The long run cost is usually lower than short run cost because of the optimization process and possibility of factors substitution