1. Chapter 8

2. COSTS McGraw-Hill/IrwinCopyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 8

3. 10-3 Chapter Outline Costs In The Short Run Allocating Production Between Two Processes The Relationship Among MP, AP, MC and AVC Costs In The Long Run Long-run Costs And The Structure Of Industry The Relationship Between Long-run And Short-run Cost Curves

4. 10-4 Costs In The Short Run Fixed cost (FC): cost that does not vary with the level of output in the short run (the cost of all fixed factors of production). Variable cost (VC): cost that varies with the level of output in the short run (the cost of all variable factors of production). Total cost (TC): all costs of production: the sum of variable cost and fixed cost.

5. 10-5 Figure 8.1: Output as a Function of One Variable Input

6. 10-6 Figure 8.1: Output as a Function of One Variable Input 0

7. 10-7 Figure 8.2: The Total, Variable, and Fixed Cost Curves (R/hr) 800 600 500 400 300 200 100 700 300

8. 10-8 Figure 8.3: The Production Function Q = 3KL, with K = 4

9. 10-9 Figure 8.4: The Total, Variable, and Fixed Cost Curves for the Production Function Q = 3KL R/hr 80

10. 10-10 Costs In The Short Run Average fixed cost (AFC): total fixed cost divided by the quantity of output. Average variable cost (AVC): total variable cost divided by the quantity of output. Average total cost (ATC): total cost divided by the quantity of output. Marginal cost (MC): change in total cost that results from a 1-unit change in output.

11. 10-11 Graphing The Short-run Average And Marginal Cost Curves Geometrically, average variable cost at any level of output Q may be interpreted as the slope of a ray to the variable cost curve at Q.

12. 10-12 Figure 8.5: The Marginal, Average Total, Average Variable, and Average Fixed Cost Curves R/hr R/unit of output 0 0

13. 10-13 Figure 8.6: Quantity vs. Average Costs R/unit of output 10 20 30 40

14. 10-14 Marginal Costs Is the same as the cost of expanding output (or the savings from contracting). By far the most important of the seven cost curves. Geometrically, at any level of output it may be interpreted as the slope of the total cost curve at that level of output. – And since the total cost and variable cost curves are parallel, is also equal to the slope of the variable cost curve.

15. 10-15 Marginal and Average Costs When MC is less than average cost (either ATC or AVC), the average cost curve must be decreasing with output; and when MC is greater than average cost, average cost must be increasing with output.

16. 10-16 Figure 8.7: Cost Curves for a Specific Production Process R/hr R/unit of output 80 200 20 100

17. 10-17 Allocating Production Between Two Processes Let Q T be the total amount to be produced, and let Q 1 and Q2 be the amounts produced in the first and second processes, respectively. And suppose the marginal cost in either process at very low levels of output is lower than the marginal cost at Q T units of output in the other (which ensures that both processes will be used). The values of Q 1 and Q 2 that solve this problem will then be the ones that result in equal marginal costs for the two processes.

18. 10-18 Figure 8.8: The Minimum Cost Production Allocation 00

19. 10-19 Figure 8.9: The Relationship Between MP, AP, MC, and AVC 0 0

20. 10-20 Costs In The Long Run Isocost line: a set of input bundles each of which costs the same amount. To find the minimun cost point we begin with a specific isoquant then superimpose a map of isocost lines, each corresponding to a different cost level. – The least-cost input bundle corresponds to the point of tangency between an isocost line and the specified isoquant.

21. 10-21 Figure 8.10: The Isocost Line 0

22. 10-22 Figure 8.11: The Maximum Output for a Given Expenditure 0

23. 10-23 Figure 8.12: The Minimum Cost for a Given Level of Output 0

24. 10-24 Figure 8.13: Different Ways of Producing 1 Ton of Gravel 0

25. 10-25 Figure 8.14: The Effect of a Minimum Wage Law on Employment of Skilled Labour Skilled labour (s) Unskilled labour (u) 0

26. 10-26 The Relationship Between Optimal Input Choice And Long-run Costs Output expansion path: the locus of tangencies (minimum cost input combinations) traced out by an isocost line of given slope as it shifts outward into the isoquant map for a production process.

27. 10-27 Figure 8.15: The Long-Run Expansion Path 0

28. 10-28 Figure 8.16: The Long-Run Total, Average, and Marginal Cost Curves R/hr R/unit of output

29. 10-29 The Relationship Between Optimal Input Choice And Long-run Costs Constant returns to scale - long-run total costs are thus exactly proportional to output. Decreasing returns to scale - a given proportional increase in output requires a greater proportional increase in all inputs and hence a greater proportional increase in costs. Increasing returns to scale - long-run total cost rises less than in proportion to increases in output.

30. 10-30 Figure 8.17: The LTC, LMC and LAC Curves with Constant Returns to Scale R/unit of outputR/unit of time

31. 10-31 Figure 8.18: The LTC, LAC and LMC Curves for a Production Process with Decreasing Returns to Scale R/unit of timeR/unit of output

32. 10-32 Figure 8.19: The LTC, LAC and LMC Curves for a Production Process with Increasing Returns to Scale R/unit of timeR/unit of output

33. 10-33 Long-run Costs And The Structure Of Industry Natural monopoly: an industry whose market output is produced at the lowest cost when production is concentrated in the hands of a single firm. Minimum efficient scale: the level of production required for LAC to reach its minimum level.

34. 10-34 Figure 8.20: LAC Curves Characteristic of Highly Concentrated Industrial Structures R/Q 0

35. 10-35 Figure 8.21: LAC Curves Characteristic of Unconcentrated Industry Structures R/Q 00 0

36. 10-36 Figure 8.22: The Short-run and Long-Run Expansion Paths

37. 10-37 Figure 8.23: The LTC and STC Curves Associated with the Isoquant Map in Figure 8.22 R/unit of time 0

38. 10-38 Figure 8.24: The LAC, LMC, and Two ATC Curves Associated with the Cost Curves from Figure 8.23 R/Q 0

39. 10-39 Figure 8.25: The Family of Cost Curves Associated with a U-Shaped LAC R/Q 0

40. 10-40 Figure 8.26 The Learning Curve 50 30 300 400 500 200100 20 40 0 Hours of labour per machine lot Cumulative number of machine lots produced

41. 10-41 Figure 8.27: Economies of scale versus learning effect 0 Cost (R per unit of output) Output Economics of Scale B C A Learning ATC 1 ATC 2