Chapter 7 (Week 4) Flashcards
Economists include all relevant costs
Including all required inputs such as labour, capital, energy, and materials
Explicit costs (out of pocket expenses)
actual expenses, which are visible but don’t represent all economic costs
payments for inputs to its production process within a given period
Implicit costs
expenses, that aren’t directly visible or considered when thinking about the costs
forgone opportunity rather than an explicit expenditure
Economic costs (opportunity costs)
these are costs associated with foregone opportunities. Such costs are often hidden but should be considered
Value of the best alternative use of a resource, and it includes both explicit and implicit costs
Sunk costs
costs that aren’t changeable by decision making - it can’t be recovered so the opportunity cost is 0
Fixed costs
costs that don’t vary with the amount of production
Variable costs
costs that vary with each added or subtracted unit of production
Total costs
fixed costs + variable costs
Marginal cost
Extra cost from producing one more unit of output
Intersects the AVC and AC at their minimum
Derivative of TC
Formula to find MC
Change in TC / Change in q
Change in VC / Change in q
Average fixed costs
Fixed cost divided by the units of output produced
Decreases as the quantity increases
Average variable costs
Variable cost divided by the units of output produced
Always lower than ATC because ATC = AVC + AFC
Average cost
Total cost divided by the units of output produced
Firms make profit if the average cost is the average revenue
Slope of the variable cost =
Height of the marginal cost curve
User cost of capital
Annual costs of owning and using a capital asset
User cost of capital = economic depreciation + (interest rate x value of capital)
Relationship between MC and AVC curve
Intersect at minimum of AVC curve
MC curve has the same slope like the AVC curve at the intersect
MC < AVC → AVC slopes downwards → AC slopes downwards
MC > AVC → AVC slopes upward → AC slopes upwards
Diminishing marginal returns to labour
each extra workers increases output by a smaller amount
Effect of taxes on cost
Taxes usually shift some or all of the marginal and average cost curves
They affect the AC, AVC and MC curve
Maximal price regulation
price is regulated so that it isn’t higher than a certain Pmax - Supply falls
Minimal price regulation
price of a good has been regulated to be no lower than Pmin. - Demand drops
Price support
the government buys excess supply in order to artificially inflate prices, so that P goes up - demand drops
Long run
Firm adjusts all its inputs to minimise its cost of producing a given output level.
Isocost line
Line connecting all possible combinations of inputs that can be purchased for a given cost
C = wL + rK
Slope = - w / r
Approaches to minimise cost
The firm can choose any of the three equivalent approaches to minimise cost:
Lowest isocost rule: pick the bundle of inputs where the lowest isocost line touches the isoquant –> - MPL / MPK = - w / r
Tangency rule: pick the bundle of inputs where the isoquant is tangent to the isocost line
Last dollar rule: pick the bundle of inputs where the last dollar spent on one input gives as much extra output as the last dollar spent on any other input –> MPL / w = MPK / r
Long run expansion path
The cost minimising combination of labour and capital for each output level - the curve through the tangency points
Diseconomies of scale
Average costs of production increase as output increases
Economies of scale
Average costs of production fall as output increases
A firm’s average cost may fall over time for three reasons
Operating at a larger scale in the long run may lower average cost due to increasing returns to scale
Technological progress may increase productivity and thereby lower average cost
A firm may benefit from learning by doing - the productive skills and knowledge that workers and managers gain from experience
Learning is a function of cumulative output: the number of units of output produced since the firm began production
Learning curve
the relationship between average costs and cumulative output
Externalities
Occurs when a person’s well being or a firm’s production capability is directly affected by the actions of other consumers or firms rather than indirectly through changes in prices
Negative: hurts someone
Positive: benefits others
