Ch07_Pindyckfinal

# Ch07_Pindyckfinal - Chapter 7 The Cost of Production...

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Chapter 7 The Cost of Production

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Dr. Carlos Asarta Chapter 7 2 Measuring Cost: Which Costs Matter? Although opportunity costs are hidden and should be taken into account, sunk costs should not Sunk Cost Expenditure that has been made and cannot be recovered Should not influence a firm’s future economic decisions
Dr. Carlos Asarta Chapter 7 3 Prospective Sunk Cost An Example Firm is considering moving its headquarters A firm paid \$500,000 for an option to buy a building The cost of the building is \$5 million for a total of \$5.5 million The firm finds another building for \$5.25 million Which building should the firm buy?

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Dr. Carlos Asarta Chapter 7 4 Prospective Sunk Cost Example (cont.) The first building should be purchased The \$500,000 is a sunk cost and should not be considered in the decision to buy What should be considered is Spending an additional \$5,250,000 or Spending an additional \$5,000,000
Dr. Carlos Asarta Chapter 7 5 Measuring Cost: Which Costs Matter? Some costs vary with output, while some remain the same. Total cost can be divided into: 1. Fixed Cost Does not vary with the level of output 2. Variable Cost Cost that varies as output varies

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Dr. Carlos Asarta Chapter 7 6 Fixed and Variable Costs The total cost of production equals the fixed cost (the cost of the fixed inputs) plus the variable cost (the cost of the variable inputs), or… VC FC TC + =
Dr. Carlos Asarta Chapter 7 7 Fixed and Variable Costs Which costs are variable and which are fixed depends on the time horizon Short time horizon – most costs are fixed Long time horizon – many costs become variable In determining how changes in production will affect costs, must consider if fixed or variable costs are affected.

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Dr. Carlos Asarta Chapter 7 8 Fixed Cost Versus Sunk Cost Fixed cost and sunk cost are often confused Fixed Cost Cost paid by a firm that is in business regardless of the level of output Sunk Cost Cost that has been incurred and cannot be recovered
Dr. Carlos Asarta Chapter 7 9 Marginal and Average Cost In completing a discussion of costs, must also distinguish between Average Cost Marginal Cost After definition of costs is complete, one can consider the analysis between short- run and long-run costs

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Dr. Carlos Asarta Chapter 7 10 Measuring Costs Marginal Cost (MC): The cost of expanding output by one unit Fixed costs have no impact on marginal cost, so it can be written as: Δq ΔTC Δq ΔVC MC = =
Dr. Carlos Asarta Chapter 7 11 Measuring Costs Average Total Cost (ATC) Cost per unit of output Also equals average fixed cost (AFC) plus average variable cost (AVC) q TVC q TFC q TC ATC + = = AVC AFC q TC ATC + = =

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Dr. Carlos Asarta Chapter 7 12 A Firm’s Short Run Costs (7.1)
Dr. Carlos Asarta Chapter 7 13 Determinants of Short Run Costs If marginal product of labor decreases

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## This document was uploaded on 11/29/2009.

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Ch07_Pindyckfinal - Chapter 7 The Cost of Production...

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