Econ 4010 Lecture 13

Econ 4010 Lecture 13 - 7. The Cost of...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
In the last two classes, we examined the firm's production technology – the relationship that shows how factor inputs can be transformed into outputs. Now we will see how the production technology, together with the prices of factor inputs, determines the firm's cost of production. Opportunity Cost is the cost associated with opportunities that are forgone when a firm's resources are not put to their best alternative use. For example, consider a firm that owns a building and therefore pays no rent for office space. Does this mean that the cost of office space is zero? Economists would note that the firm could have earned rent on the office space by leasing it to another company. This forgone rent is the opportunity cost of utilizing the office space. Sunk Cost is an expenditure that has been made and cannot be recovered. For example, consider the purchase of specialized equipment for a plant. Suppose the equipment can be used to do only what it was originally designed for and cannot be converted for alternative use. The expenditure on this equipment is a sunk cost. Because it has no alternative use, its opportunity cost is zero. Total Cost (TC or C) is divided into two components: Fixed Cost and Variable Cost. Fixed Cost (FC) is a cost that does not vary with the level of output and that can be eliminated only by going out of business. It may include expenditures for plant maintenance, insurance, and perhaps a minimal number of employees. Variable Cost (VC) is a cost that varies as output varies. Which costs are variable and which are fixed depends on the time horizon that we are considering. Over a very short time horizon – say, one or two months – most costs are fixed. Over such a short period, a firm is typically obligated to receive and pay for contracted shipments of materials and cannot easily lay off workers. On the other hand, over a long time horizon – say two or three years – many costs become variable. Over this time horizon, if the firm wants to reduce its output, it can reduce its workforce, purchase fewer raw materials, and perhaps even sell off some of its capital. People often confuse fixed and sunk costs. Fixed costs can be avoided if the firm goes out of business. Sunk costs, on the other hand, are costs that have been incurred and can not be recovered. Marginal Cost (MC) is the increase in cost that results from producing one extra unit of output. MC tells us how much it will cost to expand output by one unit. MC = ∆VC / ∆Q = ∆TC / ∆Q Average Cost (AC or ATC) is the firm's total cost divided by its level of output, TC / Q. Average Fixed Cost (AFC) is FC / Q. Average Variable Cost is VC / Q. 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 03/31/2009 for the course ECON 4010 taught by Professor Cheng during the Spring '09 term at USC.

Page1 / 6

Econ 4010 Lecture 13 - 7. The Cost of...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online