CH10new07 - Chapter 10 COSTS Boiling Down Chapter 10 The...

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Chapter 10 COSTS Boiling Down Chapter 10 The reason we spent so much time in the last chapter trying to identify the relationship between inputs and outputs is that inputs represent the cost of producing a given output. As in the case of production inputs, we are concerned with the capital and labor input costs rather than the raw material costs because the raw materials are not part of the value added to the product. What follows will sound like technical nonsense unless it is read slowly with a sketch pad to graph the thoughts of the paragraphs. It will make much more sense and clinch much of the material if it is read again after the material is digested and understood. The graph below shows some of the concepts discussed here. ATC, AVC ATC Falling AFC overpowers diminishing returns AVC MC Quantity Increasing returns diminishing returns The short-run total cost of a given output is equal to the cost of the fixed inputs plus the cost of the variable inputs. To find the cost per unit (average cost) of output, the total cost is divided by the quantity produced. The average total cost is influenced by several factors. Because increasing and then diminishing returns are part of the production function characteristics, average variable costs are pulled down initially because early additions of the variable input make the production recipe more efficient. This pulls down all the cost curves shown in the graph. However, at the point of diminishing returns this trend reverses and marginal cost begins to rise. When MC goes above AVC it pulls up the AVC and when it goes above the ATC it begins to overpower the pull down on average costs from falling AFC. At his point the ATC begins to rise indefinitely. The key factor in understanding cost is to recognize that, as labor is added to a fixed production process, the mix between labor and the fixed capital stock varies from being too little labor in the factory to too much labor in the factory. In both cases, ATC will be higher than it is when labor and capital are in the best balance. The U shape of ATC is
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CHAPTER 10: Costs thus a result of increasing and then diminishing returns to production and the fact that AFC must continuously decline. Marginal costs can be obtained by calculating the change in total cost, which means that only variable cost is relevant in the MC calculations. Fixed costs can never change total cost. In graphing all these relationships, it is important to remember that the slope of any total function is the marginal value, and the slope of a ray from the origin to the total function is the average value at that point on the total function. Try sketching graphs from total cost curves, total variable cost curves, and total fixed cost curves. The real reason why we make all this effort to understand the way costs respond to
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This note was uploaded on 05/25/2008 for the course ECON 73-150 taught by Professor Dubra during the Spring '08 term at Carnegie Mellon.

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CH10new07 - Chapter 10 COSTS Boiling Down Chapter 10 The...

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