Costs Flashcards
What are economic costs?
- Economic consider all costs relevant for an economic decision: explicit + implicit (op cost of next best alternative) but not including sunk costs
If we assume all inputs can be sold in competitive markets: econ. costs =
= opportunity costs = market value
What are accounting costs?
- only explicit
- = historical values
What is true of labour costs?
- Econ & Acc. costs similar
- Assume w = amount that can be paid in next best alternative employment
What is true of capital costs?
- Econ & acc. costs differ
- Economists generally consider large K costs as sunk
What are entrepreneurial costs?
- Starter/Owner of business is entitled to some share of profits/loss = wage they would get elsewhere
What is the definition, slope and intercepts of an isocost?
- Different combinations of K and L that give the same TC
- slope: -w/v i.e. linear
- Intercepts: TC/v TC/w
In cost minimisation, what assumption do we make about inputs and what is the implication?
- Assume both hired in perfectly competitive input markets
- w = VMPL
- v = VMPK
- i.e. both having horizontal supply curves at w and v
In Cost min, TC =
= wL + vK
In Cost min, TR =
= pq = pf(K,L)
In Cost min, π =
TR - TC = pf(K,L) - wL - vK
In the cost min model, what is done first?
- Fix output at given amount : q0
- π = pq0 - wL - vK
- Price constant and exogenous quantity, firm can only profit maximise by minimising costs
Where does cost min occur?
- Cost minimising bundle of K & L is where isocost is tangent to isoquant
- w/v = MRS (= MPL/MPK = K/L)
- MPL/w = MPK/v
What is true if MRS > w/v?
use less K and more L
What is important about cost min optimisation?
- If MRS = 2,
- if K decrease by 2, need to increase L by 1 unit to stay on same isoquant (b/c MRS!)
etc.
What if MPL/w ≠ MPK/v?
- If MPL/w > MPK/v, the additional output from 1 more unit of labour per dollar is greater than the additional output from 1 unit of capital per dollar, and more labour should be hired - hire more productive asset
What is an expansion path?
- Shows the cost min bundles of inputs needed as output increases (no change in isocost other than shifts i.e. assume w/v constant)
- Curvature is determined by production function and c/i/d returns to scale
- Shows the relationship between Q and TC
IN Q vs TC SPACE
What is a CRTS expansion path?
- Straight line
- q and input use increase proportionally
- TC will also increase accordingly - proportionally
What is a DRTS expansion path?
- Exponential line
- As q increases TC increase but a an increasing rate
What is an IRTS expansion path?
- Plateuing line
- As q increases TC increases at a decreasing rate
- i.e. need to increase K and L in smaller proportions
What is true of a mixed expansion path?
- Efficient scale at tangency point
AC =
- AC = TC/Q
MC =
- MC = ∆TC/∆Q = ∂TC/∂Q
In what space are AC and MC compared with RTS?
$(Y) vs Q(X)
What is the relationship in graphical space between AC and MC when there are CRTS?
- Each unit has the same AC = MC
- Straight horizontal lines
What is the relationship in graphical space between AC and MC when there are DRTS?
- When TC is increasing at an increasing rate - AC of production is increasing
- MC must lie above AC
What is the relationship in graphical space between AC and MC when there are IRTS?
- AC is decreasing as output increases
- MC lies below AC
What does increasing AC mean and what does it not mean?
Increasing AC = Diseconomies of scale BUT ≠ DRTS
What does decreasing AC mean and what does it not mean?
Decreasing AC = Economies of scale BUT ≠IRTS
When we are producing what costs are we interested in?
interested in MC and VC
When we are considering entering a market what are we interested in?
MC, VC AND FC
What does it mean if we have a fixed input in cost minimisation?
Having a fixed asset means that in the SR, we can’t achieve our cost-min bundle for changing production levels, so cost will be higher than they otherwise would be: SRAC > LRAC
i.e. LMC and LAC lie under SMC and SAC
How do we represent having a fixed input in cost minimisation?
K (for instance) stuck on horizontal limit, and cost min tangency must be at the level
Specifically what things shift cost curves?
- Input Prices
- Tech
- Economies of Scope
What occurs to the expansion path with an increased wage?
- Expansion path for higher L costs pivots towards the K-axis
What is true of tech advancement?
Can be equal or biased towards one input
How can we tell the RTS from the production function?
- Indices add up to 1 = CRTS
- Indices add up to > 1 = IRTS
In a longer form, how can we determine RTS from the production function?
By looking at what happens to output if you increase both inputs proportionally
With one input fixed and output given, how can we determine an isoquant (not equation)?
- Devise all different combinations of K & L (from production function) that will give Q
- Plot
What is the cost min bundle?
- Cost min bundle: w/v = MRTS (= MPL/MPK = K/L)
With one input fixed and output given what are the steps to cost min?
- Input costs into cost min bundle: w/v = K/L
- From this determine RATIO of K to L at cost min
- Plug this proportion into production function
- Determine K and L from doing this
(5. Plug this into TC equation and answer = isocost)
(6. Determine isocost intercepts)
What is the difference between RTS and EoS?
RTS - Production
EoS - Cost Structure
What is true of the isoquant when w/v changes in cost min?
Isoquant must shift (change output) if w/v changes and one input is fixed
