1. Costs Lesson aims: To be define fixed, variable and semi-variable costs To be able to define total cost, average cost and marginal cost To be able to calculate total cost, average cost and marginal cost, as well as average fixed cost and average variable cost

2. Starter (3 minutes): Define: a)Fixed costs b)Variable costs c)Give examples of each

3. Costs The economic cost is the opportunity cost for a firm (or individual) – the value that could have been generated had the next best alternative been used.

4. Imputed cost Resources which have an opportunity cost, but no payment is made is called an imputed cost. For example: Labour – Opportunity cost of time Financial capital – Other use of investment, e.g. savings/interest Depreciation – Physical capital, e.g. machinery/vehicles loses value over time Goodwill – Reputation/brand image could be sold.

5. Fixed, variable and semi-variable costs Fixed cost – A cost that does not vary with output, e.g. rent Variable cost – One that increases as output goes up, e.g. raw materials Semi-variable cost – An amalgamation, e.g. labour; could be salary combined with overtime.

6. Activities (10 minutes) Question 1, p.288 Question 2, p.289

7. Total, average and marginal cost Total cost (TC) is the cost of producing at a given level of output. It includes total fixed cost (TFC) and total variable cost (TVC). TC = TFC + TVC(see Table 1) Average cost (AC) is the total cost divided by the level of output and is made up of average fixed cost (AFC) and average variable cost (AVC); AC = TC ÷ Q(see Table 2) Marginal cost (MC) is the cost of producing an extra unit of output; it is the difference between the total cost when output changes: MC = ΔTC ÷ ΔQ(see Table 3)

8. Now (10 minutes) Question 3, p.290

9. Short run and long run Lesson aims: To be able to distinguish between the short run, the long run and the very long run To have an understanding and be able to explain the law of diminishing returns

10. Starter (3 minutes): What do you think is meant by: a)The short run b)The long run c)The very long run

11. Short run and long run Short run – some (at least one) factor of input is fixed in supply (think back to land and crops…). Long run – All factor inputs are variable, production is more flexible. Very long run – Technological advancements increase efficiency and productive potential.

12. The law of diminishing returns Think of a field on a farm that potatoes can be dug from…a farmer has plenty of space, but can’t make most use of it… More workers are added to dig up to the most productively efficient point… Yet more workers are added…what happens? They get into each others’ way, have to wait to use the spades, only so much field to dig, and so on… This is the law of diminishing returns! (In the long run, more potato plants, fields, etc…)

13. Short run cost schedules Look at table 6: TFC (capital per unit) = £100 per unit, but is always 10; therefore £1000. TVC (labour) = £200 per unit. TC = TFC + TVC. From here, we can calculate ATC (AFC + AVC) and: MC. MC per unit = cost of additional labour ÷ output (posh word: marginal physical product (MPP) (you don’t necessarily need to fully understand or appreciate this)). Now, to show this; the extra cost of the worker is £200, the change in output (from 1 to 2 = 34) £200 ÷ 34 = 5.9 (rounded up).

14. Question 4, p.290 (10 minutes)

15. Short run cost curves We can show the data from table 6 in the form of graphs, or short run cost curves. See fig. 1 (a) – notice how TFC is constant and TVC therefore TC is upward sloping. Fig. 1 (b) – AFC falls as the higher the output, the lower the proportion paid (in SR) ATC (The AC curve) falls at first, as does AVC, as output increases and becomes more efficient – it rises when diminishing average returns set in. In a similar vein, the MC curve falls and then rises as diminishing marginal returns set in.

16. Points to note For reasons noted on the previous slide, the MC and AC curves are ‘U-shaped’. The MC curve cuts the AC curve at its lowest point. Read student height example, p.292. If AC is falling, the MC (cost of extra unit of output) must be less than AC; and vice versa if AC is rising. The same goes for the AVC curve. If AC was constant, so too would be MC.

17. Question 5, p.292 (10 minutes)

18. Economies of scale and long run average cost Lesson aims: To understand the concept of economies and diseconomies of scale To be able to define the optimal level of production To understand the relationship between short run average cost curves at different levels of output and the long run average cost curve

19. Starter (3 minutes): Define: a)Economies of scale b)Diseconomies of scale c)Give examples of types of economies of scale

20. Economies and diseconomies of scale (LRAC) If long run costs fall as output is increasing, a firm has economies of scale. The more the business is producing, the cheaper the average cost is becoming. If the average costs rises as output is increasing, a firm is experiencing diseconomies of scale. Look at fig. 2 (LRAC curve), p. 293.

21. The optimum level of production As we know, the LRAC curve is U-shaped because of economies and diseconomies of scale setting in. A firm is productively efficient or at the optimal level of production when average costs are at their lowest; the bottom of the LRAC curve (this can be a range, as in fig.2). Where the lowest point begins is called the minimum efficient scale (MES). If the curve is flat, there are constant returns, as diseconomies of scale set in, the firm is said to experience increasing returns. Draw fig. 2

22. Question 6, p.293 Question 7, p.293 (10 minutes)

23. Movements and shifts in the long run average cost curve As seen, the LRAC is u-shaped, but acts as a boundary for the lowest level of average costs at a given level of output. Look at fig. 3, p.294. Anything above the boundary line is less efficient than being ‘on the line’ – think back to PPFs… The LRAC could shift down, due to external economies of scale; or upwards because of external diseconomies of scale.

24. Relationship between SRAC and LRAC curve Now, put all of the theory surrounding short run average cost curves and long run average cost curves together… Look at fig. 4. The SRAC curve is ‘u-shaped’, and there are a variety of outputs the firm could produce at. Take the first; B is more efficient (lower cost) than A, but it can’t produce at C (short run), even though C would be more efficient. Apply the same thinking to the other two SRAC curves. Combining the SRAC curves, we get a LRAC curve, which acts as a boundary, or ‘envelope’ to the SRAC curves. A, C, D, F and G are the least cost points in the long run. If the firm produces in the short run where the SRAC is tangential to (touches) the LRAC, it is where it would produce if all factor inputs were variable (long run). Draw fig. 5

25. Question 9, p.295 (10 minutes)

26. Homework Container shipping, p.298-299. Make sure you ask for help if you need it.