# Ch07 - Chapter7 TheCostofProduction 1 TopicstobeDiscussed...

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1 Chapter 7 The Cost of Production

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2 Topics to be Discussed Economic & Accounting Cost LR Versus SR Cost Curves Economies of Scope The Learning Curve Estimating and Predicting Cost
3 Ch. 7 Exercises (page 254) 7.1 #1, 5 7.2 #2, 4, 9 7.3 #10, 11 7.4 – 7.6 #12, 14 AppendixDo all exercises

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4 7.1 Which Costs Matter? Economic Cost  = Explicit + Implicit Costs  What’s Implicit? What doesn’t show up on accounting  statements? Ex. 1: owner/manager who does not draw salary Cost = market value of owner’s work Ex. 2: A firm owns its own building (or other capital) Next best use of building?   Cost = Foregone rent
5 Which Costs Matter? Somethings on accounting statements do not matter: Sunk Cost Unrecoverable expenditures Should not be counted!  (i.e. Econ Cost = 0) Do not influence a firm’s future economic decisions Ex. 3: equipment that cannot be converted to another use No alternative use    Cost = 0

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6 7.2 Short Run Cost Curves Output Cost (\$ per year) 100 200 300 400 0 1 2 3 4 5 6 7 8 9 10 11 12 13 VC VC (varies with Q) TC TC = FC + VC FC 50 FC constant
7 Short Run Costs Average Total Cost (ATC) Cost per unit of output AVC AFC q TVC q TFC q TC ATC + = + = =

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8 Short Run Costs Marginal Cost (MC): ~The cost of expanding output by 1 unit Fixed costs have no impact on marginal cost, so it can  be written as: VC q TC q MC = =
9 Short Run Cost Curves AVC = slope of the  line drawn from the  origin to the VC curve MC = slope at a point  on VC (or TC) Note, MC = AVC   at q  =7 1 2 3 4 5 6 7 8 9 10 11 12 13 Output P 100 200 300 400 FC VC TC A

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10 Short Run Cost Curves MC < ATC    ATC  decreases MC > ATC  increases Output (units/yr.) Cost (\$ per unit) 25 50 75 100 0 1 2 3 4 5 6 7 8 9 10 11 MC ATC AVC AFC
11 Short Run Costs: Determinants If wage rate ( w ) is fixed, then VC increases at a  rate of ( w  ∙∂L) Eventually Diminishing MP L        Eventually increasing MC L MP w q L w = = MC

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12 7.3 Long Run Cost L and K variable Assume firm takes input prices as given w  = wage rate r  = rental rate     Express cost as a flow (\$/year)
13 User Cost of Capital K is either rented or purchased Rented: There is a rental rate,  r   Purchased: User cost?  User Cost of Capital      = Econ Depr.  Forgone Interest  User cost can also be described as a rate: r = Depreciation Rate + Interest Rate In a competitive market, this equals the  rental rate

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14 Cost Minimization  Firms choose (L,K) to minimize the cost of  producing output  MIN C = wL + rK  subject to F(L,K) = Q 0
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Ch07 - Chapter7 TheCostofProduction 1 TopicstobeDiscussed...

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