Costs Flashcards
How are economic costs different?
Economist use, economic costs or opportunity costs to evaluate the cost of resources
What is an implicit cost?
Opportunity costs.
What is an explicit cost?
Out of pocket costs for the firm. E.g Cost of acquiring labour, capital, energy and materials.
Opp cost is simply the market price
What is capital?
A durable good which provides services over a long period (land, equipment, buildings) used for further production
How do you measure opportunity cost of capital when capital is rented?
Simply the rental price.
Even if capital is purchased, the opp cost of using capital is the amount a firm could earn by renting it out to someone else so they can still use market rental rate to measure cost of capital.
What are fixed costs?
(F) Costs that do not vary with the level of output q
What is an example of fixed cost?
Rent, salaries of permanent employees
What are variable costs ? (VC)
Costs that vary with the level of output
What are variable costs?
Raw materials, labour (not always fully variable but assume for simplicity)
Total costs or just costs (C) are?
The sum of fixed and variable costs
What is the formula for C
C = F + VC
What are marginal costs?
Change in total costs if the firm produces an additional unit of output
Formula for MC?
Change in total cost/change in Q
Or
dC(q)/dq
AFC formula?
Fixed costs/Quantity
Trend of average fixed costs as output increases?
AFC always fall as output increases as fixed costs are spread over more units
What is AVC formula
VC/Q
Can increase or decrease with output
What is average total cost or average costs AC?
AC = AFC + AVC
What determines shape of short run cost curve?
Short run production function
What is MC in the SR cost curve?
MC = w / MP(L)
How do firms produce a given quantity of output at minimum cost?
Firms use information about their production functions and the price of production factors
What info do firms use to produce a given quantity of output at minimum cost?
Short run: only vary the amount of labour
Long run: can vary both capita and labour inputs
So long run costs will never be higher than short run costs!
What is an isocost line?
An isocost line shows combinations of inputs that require the same total cost
Isocost lines are similar to budget constraints but?
Consumers have one budget constraint only (determined by income and prices)
Firms have many isocost lines
What are the 3 properties of isocost lines?
- The firms cost level, c̅, and input prices determine where the isocost line hits the axes
- isocost further from the origin have higher costs than those closer
- slope of each isocost is the same and given by the relative prices of the inputs
For a desired level of output, which isocost does the firm choose?
A firm chooses the isocost line that minimizes its total cost for a desired level of output. In other words, the firm selects the combination of inputs (such as labor and capital) along the isocost line that allows it to produce the desired output at the lowest possible cost. This point of minimum cost is where the isocost line is tangent to the isoquant curve, representing the most cost-effective input combination for the given production level.
How is the isocost line related to the isoquant?
Isocost line is straight sloping down and isoquant is curved sloping down
Isoquant vs isocost line
• Isoquant: Represents all the combinations of inputs (like labor and capital) that produce the same level of output.
• Isocost Line: Shows all the combinations of inputs that a firm can afford given a particular cost or budget.
What do firms do when factor price changes?
Firms substitute away from the now relatively more expensive factor
E.g. if wages go down,
Isocost line becomes flatter
Standard convex isoquants - firms substitute away from capital and towards labour
How do we derive a firm’s long run expansion path and its long run cost curve?
Repeating the process of “finding cost minimising combination of inputs for a given output level”, for different output levels
How to derive a long run expansion path?
Curve through tangency points between isocost lines and isoquants for different levels of output
How to derive a long run cost curve?
Derived from long run expansion path
What does production function determine?
Shape of SR & LR cost curves
A cost function exhibits economies of scale if average costs …?
Economies of scale if average costs fall as output goes up
When does economies of scale (avg cost fall as output increase) happen for fixed Factor prices?
For fixed factor rices this happens if underlying production function has IRS (inc returns to scale)
Or doubling all inputs
When does a firm exhibit diseconomies of scale?
If average costs rise as output rises.
Also if underlying production function has decreasing returns to scale DRS
Why do we often find a U shaped or L shaped pattern for avg costs as output goes up?
- increasing then decreasing returns to scale
- this is because the shape of long run cost curves is determined by the shape of the production function
What happens in a U shaped pattern for average costs?
First decreasing average costs as we are on the IRS part of production function, then increasing average costs as we move to the DRS part
What happens in an L shaped avg cost pattern?
First decreasing, then constant average costs
(IRS -> CRS)
In the long run costs cannot?
Cannot be higher in the LR than the SR
Why can’t long run costs be higher than in the short run?
We can’t vary capital in the short run so we might have to produce with a suboptimal level of capital.
Also the firm could always choose same level of capital stock as in the short run so they never can be worse of in the long run.
A firms cost in the SR can be described using?
Cost-level curves [Total, fixed & variable]
And cost-per-unit curves [Average total, Average fixed and AVC, MC]
Given constant input prices, the shapes of cost curves are determined by a firm’s…?
Production function
