Study Guide for Whinston and Bernheim
Technology and production, the topics of chapter 7, examined the physical relationship
between inputs and outputs.
Those were real flows of labor and machine time combining
to produce real benches and apple cider and consulting services.
We learned less about
how actually to produce things than we learned about how consistently to represent those
relationships and look for regularities like the Law of Diminishing Marginal Returns and
returns to scale.
Frankly, that chapter was not intended to teach us how to build benches
or press apple cider, though we might have gained a little insight into those processes.
Production theory’s real purpose was to show us where production costs come from.
was to lay the foundations for this chapter, where we take a close look at those
We begin with some definitions:
is the expenditure (in the true economic
sense) required to produce any given level of output. This is almost tautologically true;
it’s really sort of self evident.
It says, take everything you spend on labor and everything
you spend on capital (and all the other inputs), add them up, and there you have your
If some of those costs vary as output changes, we call them
some of those expenditures remain the same no matter how much output we produce, we
We extend the definitions by looking more closely at fixed costs and ask the question,
really fixed? Or are they just fixed as long as we are producing some positive level of
For example, you might be reading the text in your college library.
insurance on the library is fixed whether or not you or anybody else is taking advantage
of the library to study.
That means when the last student leaves, that cost still prevails.
unavoidable fixed cost,
also known as
. But another fixed cost is the
electricity bill to light the reading room.
It doesn’t matter whether you are the only
reader or there are dozens in the room, the light bill is fixed.
But, as they say, “When the
last person leaves, hit the light switch.”
That part of fixed cost is
Now we have some vocabulary about costs, but we don’t yet have a
is the relationship between the flow of output and the total cost of producing that flow.
takes the form Total Cost = C (Output).
It includes both fixed cost and variable cost.
The fixed cost function is pretty simple; it’s just a number.
Or in the case of avoidable
fixed cost, it’s more of a toggle.
If production is positive it is “on” at a constant level; if
production is zero, so is avoidable fixed cost. By definition, variable cost changes as
output changes, so that functional relationship is the
variable cost function
Cost = VC(Output).
In the last chapter we learned about the production function, which answered the direct