1. Last class: Today: Next class: Important dates:
CDAE Class 22 Nov 9
Last class:
Problem set 5 questions
6. Costs
Today:
7. Profit maximization and supply
Quiz 7
Next class:
Important dates:
Problem set 6 due Thursday, Nov. 16
(6.1., 6.4., 6.6., 6.9., and 6.10 from the textbook)
Final exam: 3:30 – 6:30pm, Friday, Dec. 15

2. 6. Costs 6.1. Basic concepts of costs
6.2. Cost minimizing input choice
6.3. Cost curves
6.4. Short-run and long-run costs
6.5. Per unit short-run cost curves
6.6. Shifts in cost curves
6.7. An example
6.8. Applications

3. 6.3. Cost curves
Possible shapes of the total cost curve (function): relation between TC and q (Fig. 6.3)
(1) Constant returns to scale
(2) Decreasing returns to scale
(3) Increasing returns to scale
(4) Optimal scale: increasing returns to scale followed by decreasing returns to scale
Practice question:
If TC=50 for Q=20 and TC=90 for Q=40, what is the returns to scale of this production?

4. 6.3. Cost curves 6.3.2. Average cost (AC) and marginal cost (MC)
(1) What is the AC and what is the MC?
AC = TC/q
MC = ΔTC/Δq
(2) AC and MC curves (functions) (Fig. 6.4)
(a) Constant returns to scale
(b) Decreasing returns to scale
(c) Increasing returns to scale
(d) Optimal scale
Practice question:
If MC<AC, what is the returns to scale?

5. 6.3. Cost curves 6.3.2. Average cost (AC) and marginal cost (MC)
(3) Optimal scale: Relationship between AC
and MC
(4) Optimal scale: Lowest AC input choice
When MC < AC, AC is decreasing
When MC > AC, AC is increasing
When MC = AC, AC is at the minimum level.

6. 6.4. Short run and long run costs
Distinction between short run and long run
Very short run: K and L are fixed  Q is also fixed
Short run: K is fixed and L change  Q can change
Long run: both K and L can change  Q can change
Input flexibility in the short-run and long run (Fig. 6.5)
Short run: K is fixed and L can change
Long run: both K and L can change

7. 6.4. Short run and long run costs
Short-run total costs:
STC = vK* + wL = SFC + SVC
Short-run fixed, variable & total cost curves
Note that the concept “returns to scale” does not apply in the short run.

8. 6.5. Per-unit short run cost curves
Short-run average cost SAC = STC / q
Short-run marginal cost SMC = ΔSTC/Δq
SAC and SMC curves
Long-run average cost and marginal cost
Relationship between short-run and long-run
cost curves
An example: choosing an ink-jet printer or laser printer
Ink-jet: STC = q
Laser: STC = q

9. 6.6. Shifts in cost curves 6.6.1. Change in input prices (w and v)
(1) w & v change in the same proportion
-- TC, AC and MC will change
-- Expansion path will not change
(2) w & v change in difference proportion
-- Expansion path will change
Technology change
-- Expansion path?

10. 6.7. An example -- Production function
-- Total cost TC = vK + wL= 5K + 5L
-- Isoquant of q = 40
-- Total cost of producing 40 units of q
-- Cost-minimizing input choice for q=40
L* = 4 and K* = 4, TC = 40
-- Long-run expansion path & costs
-- Short-run total cost (STC), short-run average
cost (SAC) and short-run marginal cost (SMC)
-- Comparison of short-run & long-run costs

11. 6.8. Applications

12. 7. Profit maximization and supply
7.1. Goals of a firm
7.2. Profit maximization
7.3. Marginal revenue and demand
7.4. Marginal revenue curve
7.5. Alternatives to profit maximization
7.6. Short-run supply
7.7. Applications

13. 7.1. Goals of a firm
-- Maximize profit
-- Maximize TR to increase market shares
-- Maximize the utility of the manager
-- Maximize the expected profit and reduce the risk
…..

14. 7.2. Profit maximization
-- Profit  = TR – TC = Pq – TC
-- A graphical analysis (TR, TC and ) (Fig. 7.1.)
-- A better graph (handout)
--  is at the maximum level when the slope of the
profit curve is equal to zero
Slope of the total profit = M = 0
“M = 0” is equivalent to “MR=MC”
i.e., when the slope of the TR curve is equal
to the slope of the TC curve

15. 7.2. Profit maximization
-- Conclusion:  is at the maximum level when
MC=MR
-- Why is this the decision rule?
If MR > MC,  can be increased by increasing q
If MR < MC,  can be increased by decreasing q If MR = MC,  can not be increased