1. Micro Chapter 8 Costs and the Supply of Goods

2. 7 Learning Goals: 1)Bring out the role costs play in making economic decisions 2)Define and differentiate between a short-run time period and a long-run time period 3)Define and calculate costs used to make decisions 4)Relate costs to output decisions in the short run 5)Relate costs to output decisions in the long run 6)Explore the factors that cause shifts in the cost curves 7)Explain how past, present, and future costs influence production decisions

3. “From the standpoint of society as a whole, the “cost” of anything is the value that it has in alternative uses.” Thomas Sowell

4. The Economic Role of Costs

5. The demand for a product represents the voice of consumers instructing firms to produce the good. On the other hand, a firm’s costs represent the desire of consumers not to sacrifice goods that could be produced if the same resources were employed elsewhere.

6. Economic profit ≠ Accounting profit Accounting profit = total revenue – total out-of-pocket costs Economic profit = total revenue – total out- of-pocket costs – opportunity costs Zero economic profit referred to as normal profit rate

7. Short Run and Long Run Time Periods

8. You must know these 2 definitions: Short Run (SR) – a period of time in which at least one input is fixed Long Run (LR) – a period of time in which all inputs are variable; i.e. none of the inputs are fixed

9. Categories of Costs

10. Some costs are fixed – they don’t vary with quantity Some costs are variable – they vary with quantity Circle the fixed costs Average costs are per unit costs Marginal cost is the change in total cost

11. Now for alphabet soup!

12. Output and Costs In the Short Run

13. Read and reread this section carefully. The ability of a firm to make stuff (its production) is intimately tied to costs You must understand why the cost curves look like they do, AND How they are related to production

14. Here is the graph you need to know:

15. Why does MC first fall and then rise rapidly? MC initially falls for two reasons: (1) Increasing marginal returns- each additional input adds more to total output than the previous input (2) learning by doing

16. Why does MC first fall and then rise rapidly? MC rises because of diminishing marginal returns At some point, each additional input adds less to total output than the previous input Since more and more input is required, marginal cost rises rapidly

17. What’s the relationship between MC and ATC? Illustration: your GPA Let’s say you’re a sophomore with a 3.0 cumulative GPA (analogous to ATC) Suppose this semester’s GPA (analogous to MC) is 3.5 –Your new cumulative would be higher (ATC rises) Now suppose this semester’s GPA (MC) is 2.0 –Your new cumulative would be lower (ATC falls) Then, next semester’s GPA (MC) is 2.5 –Your new cumulative would still be lower (ATC still falls) Catch phrase: “the average chases the margin”

18. Output and Costs In the Long Run

19. Graph of LR Costs:

20. Why does LR ATC look like this? Because in order to produce larger quantities, the firm will need to “get bigger.” That is, they will need to increase their capital. These are typically expensive so capital costs become large which drives up LRATC.

21. Economies of scale is the benefit to the firm from becoming larger. Economies of scale means the benefit is getting bigger (ATC is falling) –Also referred to as Increasing Returns to Scale Diseconomies of scale means the benefit is negative (ATC is rising) –Also referred to as Decreasing Returns to Scale

22. Summary: In the SR, diminishing returns determine the shape of the cost curves In the LR, economies of scale determine the shape of the cost curves

23. What Factors Cause Cost Curves to Shift?

24. Cost curves shift up and down Higher costs shift curves up: 1)Resources become more expensive 2)Higher taxes 3)More, or stricter, regulations 4)Older technology Lower costs shift curves down: 1)Resources become less expensive 2)Lower taxes 3)Less regulation 4)Newer technology

25. Cost curves impact supply curves When cost curves shift up, supply shifts left When cost curves shift down, supply shifts right

26. The Economic Way of Thinking about Costs

27. Some costs should be ignored Sunk costs cannot be reversed or recovered Therefore they should be ignored (but not forgotten) when making decisions about the future Keep thinking on the margin: Continue to engage in an activity as long as the marginal benefit is greater than the marginal cost