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The Cost of Production
Chapter 7
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●
us er cos t of capital
Annual cost of owning
and using a capital asset, equal to economic
depreciation plus forgone interest.
We can also express the user cost of capital as a
rate
per dollar of
capital:
The user cost of capital is given by the
sum of the economic
depreciation and the interest (i.e., the financial return) that could
have been earned had the money been invested elsewhere.
Formally,
For simplicity, we will work with two variable
inputs: labor (measured in hours of work per year)
and capital (measured in hours of use of
machinery per year).
The Price of Capital
user cost
:
r
= Depreciation rate + Interest rate.
The Rental Rate of Capital
Cost per year of renting one unit of capital.
If the capital market is competitive,
the rental rate
should be equal to the user cost, r.
CostMinimizing Input Choice
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is ocos t line:
Graph showing all possible
combinations of labor and capital that can be
purchased for a given total cost.
total cost
C
of producing any particular output is given
by the sum of the firm’s labor cost
wL
and its capital
cost
rK:
C = wL + rK
If we rewrite the total cost equation as an equation for
a straight line, we get
K = C/r – (w/r)L
slope = Δ
K/
Δ
L
= −(
w/r
)
The Isocost Line
Producing a Given
Output at
Minimum Cos t
Isocost curve
C
1
is
tangent to isoquant
q
1
at
A
and shows
that output
q
1
can
be produced at
minimum cost with
labor input
L
1
and
capital input
K
1
.
Other input
combinations–
L
2
,
K
2
and
L
3
,
K
3
–yield the
same output but at
The Isocost Line
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When an Input
Price Changes
Facing an isocost
curve
C
1
, the firm
produces output
q
1
at point
A
.
When the price of
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This note was uploaded on 02/06/2012 for the course ECON 293 taught by Professor Akbulut during the Spring '11 term at South Carolina.
 Spring '11
 akbulut
 Microeconomics

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