CHAPTER 10Production Costs in the Short Run and Long Run In economics, the cost of an event is the highest-valued opportunity necessarily forsaken. The usefulness of the concept of cost is a logical implication of choice among available options. Only if no alternatives were possible or if amounts of all resources were available beyond everyone’s desires, so that all goods were free, would the concepts of cost and of choice be irrelevant. Armen Alchian he individual firm plays a critical role both in theory and in the real world. It straddles two basic economic institutions: the markets for resources (labor, capital, and land) and the markets for goods and services (everything from trucks to truffles). The firm must be able to identify what people want to buy, at what price, and to organize the great variety of available resources into an efficient production process. It must sell its product at a price that covers the cost of its resources, yet allows it to compete with other firms. Moreover, it must accomplish those objectives while competing firms are seeking to meet the same goals. How does the firm do all this? Clearly firms do not all operate in exactly the same way. They differ in organizational structure and in management style, in the resources they use and in the products they sell. This chapter cannot possibly cover the great diversity of business management techniques. Rather, our purpose is to develop the broad principles that guide the production decisions of most firms. Like individuals, firms are beset by the necessity of choice, which as Armen Alchian reminds us, implies a cost. Costs are obstacles to choice; they restrict us in what we do. Thus a firm’s cost structure (the way cost varies with production) determines the profitability of its production decisions, both in the short run and in the long run. Of course, there is one very good reason MBA students should know something about a firm’s coststructure. “Firms” don’t do anything on their own. It’s really managers who activate firms and make decisions that will ultimately determine whether a firm is profitable or not. Out analysis of a firm’s “cost structure” is nothing like the imagined costs on accounting statements. Accounting statements indicate the costs that were incurred when the firm produced the output that it did. Here, in this chapter, we want to devise a way of structuring costs for many different output levels. The reason is simple: We want to use this structure to help us think through the question of which among many output levels will enable the firm to maximize profits. T
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