CH7_Cost - Intermediate Microeconomics Cost Instructor Bin...

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Intermediate Microeconomics Cost Instructor: Bin Xie Spring 2015
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Short-Run Costs I Recall that the short run is a period of time in which only one input (labor) can be varied, while other inputs are fixed. I Hence short-run cost measures assume labor is variable and capital is fixed: Fixed cost (F): a cost that doesn’t vary with the level of output (e.g. expenditures on land or production facilities). Variable cost (VC): production expense that changes with the level of output produced (e.g. labor cost, materials cost). Total cost (C): sum of variable and fixed costs C = VC + F
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Short-Run Costs I To decide how much to produce, a firm uses measures of marginal and average costs: Marginal cost (MC): the amount by which a firm’s cost changes if it produces one more unit of output. MC = dC ( q ) dq Average fixed cost (AFC): FC divided by output produced AFC = F / q Average variable cost (AVC): VC divided by output produced AVC = VC / q Average cost (AC): C divided by output produced AC = C q = VC q + F q = AVC + AFC
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Production Function and Shapes of Cost Curves I The SR production function, q = f ( L , ¯ K ) , determines the shape of a firm’s cost curves. I We can write q = g ( L ) because capital is fixed in the SR I Amount of L needed to produce q is L = g - 1 ( q ) I If the wage paid to labor is w and labor is the only variable input, then variable cost is VC = wL . I VC is a function of output: V ( q ) = wL = wg - 1 ( q ) I Total cost is also a function of output: I C ( q ) = V ( q ) + F = wg - 1 ( q ) + F
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Production Function and Shapes of Cost Curves (Cont.) I Shape of the MC curve: MC = dV ( q ) dq = w dL dq . I MC moves in the opposite direction of MP L : MC = w MP L . I Shape of the AC curve: AC = F + VC q = F + wL q . I Two components: Fixed cost and Variable Cost I Spreading fixed cost over output (declining average fixed cost): AFC = F q .
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