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cost theory

# cost theory - Cost theory The Meaning of Costs Opportunity...

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Cost theory

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The Meaning of Costs Opportunity costs meaning of opportunity cost examples Measuring a firm’s opportunity costs factors not owned by the firm: explicit costs factors already owned by the firm: implicit costs
Costs Short run – Diminishing marginal returns results from adding successive quantities of variable factors to a fixed factor Long run – Increases in capacity can lead to increasing, decreasing or constant returns to scale

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Costs In buying factor inputs, the firm will incur costs Costs are classified as: Fixed costs – costs that are not related directly to production – rent, rates, insurance costs, admin costs. They can change but not in relation to output Variable Costs – costs directly related to variations in output. Raw materials, labour, fuel, etc
Costs Total Cost - the sum of all costs incurred in production TC = FC + VC Average Cost – the cost per unit of output AC = TC/Output Marginal Cost – the cost of one more or one fewer units of production MC = TC n – TC n-1 units

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Marginal Product and Costs Suppose a firm pays each worker \$50 a day. Units of Labor Total Product MP VC MC 0 0 10 0 5 1 10 15 50 3.33 2 25 20 100 2.5 3 45 15 150 3.33 4 60 10 200 5 5 70 5 250 10 6 75 300
A Firm’s Short Run Costs

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Average Costs Average Total cost – firm’s total cost divided by its level of output (average cost per unit of output) ATC=AC=TC/Q Average Fixed cost – fixed cost divided by level of output (fixed cost per unit of output) AFC=FC/Q Average variable cost – variable cost divided by the level of output. AVC=VC/Q
Marginal Cost – change (increase) in cost resulting from the production of one extra unit of output Denote “ ” - change. For example TC - change in total cost MC= TC/ Q Example: when 4 units of output are produced, the cost is 80, when 5 units are produced, the cost is 90. MC=(90-80)/1=10 MC= VC/ Q since TC=(FC+VC) and FC does not change with Q

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Cost Curves for a Firm Output Cost (\$ per year) 100 200 300 400 0 1 2 3 4 5 6 7 8
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cost theory - Cost theory The Meaning of Costs Opportunity...

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