chapter seven - an-najah videos
TRANSCRIPT
Chapter Seven
Costs
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Topics
Measuring Costs.
Short-Run Costs.
Long-Run Costs.
Lower Costs in the Long Run.
Cost of Producing Multiple Goods.
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Economic Cost
Economic cost or opportunity cost -the value of the best alternative use of a resource.
Explicit costs - firm’s direct, out-of-pocket payments for inputs to its production process during a given time period. ,
Workers’ wages, managers’ salaries, etc. and payments for materials.
Implicit costs – cost of use inputs that may not have an explicit price.
value of the working time of the firm’s owner
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Economic Vs Accounting Cost
According to Bookkeepers:
The purpose of cost estimation:
a. To minimize firm’s tax for this year
b. To reflect good impression for stock holders about the firm’s performance
SO: Accounting Profits = TR – TC
Where TC = Explicit costs, such as:
- Wages - Salaries - Rent
- Row material payment
- Amortization OR (Depreciation)
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Economic Vs Accounting Cost
According to Economists:
To run a firm profitably, a manager acts like an economist and consider all relevant costs:
SO: Econ. Profits = TR – TC
Where TC = Explicit cost + Implicit cost
- Explicit costs do not contain depreciation, economists amortizes capital using the rule of the best rental rate for capital, which is an implicit cost
- Implicit cost: Such as:
a. Opportunity cost for capital, or the best alternative use (Rental rate)
b. Opportunity cost for the production factors owned to owner, or the best alternative use.
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Short-Run Cost Measures
Fixed cost (F) - a production expense that does not vary with output.
Variable cost (VC) - a production expense that changes with the quantity of output produced.
Cost (total cost, C) - the sum of a firm’s variable cost and fixed cost:
C = VC + F
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Marginal Cost.
marginal cost (MC) - the amount by which
a firm’s cost changes if the firm produces
one more unit of output.
And since only variable costs change with
output:
q
CMC
q
VCMC
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Average Costs.
average fixed cost (AFC) - the fixed cost divided by the units of output produced:
AFC = F/q.
average variable cost (AVC) - the variable cost divided by the units of output produced:
AVC = VC/q.
average cost (AC) - the total cost divided by the units of output produced:
AC = C/qAC = AFC + AVC.
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Table 7.1 Variation of Short-Run
Cost with Output
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Figure 7.1 Short-
Run Cost Curves
120
216
400
48
0 6 10
10
42 8
Quantity, q, Units per day
Quantity, q, Units per day
6
b
a
B
A
42 8
C
F
1
1
27
20
VC
MC
AC
AVC
AFC
Cost, $
Cost per
unit,
$
(a)
(b)
60
2827
20
8
0
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Relationship between average and
marginal cost curves
10
Quantity, q, Units per day
6
b
a
42 8
MC
AC
AVC
Co
st
per
un
it,
$ 60
2827
20
8
0
When MC is
lower than
AVC, AVC is
decreasing…
and when MC is
larger than AVC,
AVC is increases
…so MC = AVC, at
the lowest point of
the AVC curve!
When MC is
lower than
AC, AC is
decreasing…
and when MC is
larger than AC,
AC is increases
…so MC = AC, at
the lowest point of
the AC curve!
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Figure 7.2 Variable Cost and Total
Product of Labor
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Shape of the Marginal Cost Curve
MC = VC/q.
But in the short run,
VC = w.L (can you tell why?)
Therefore,
MC = w.(L/q)
The additional output created by every additional unit of labor is:
q/ L = MPL
Therefore,
MC = w/ MPL
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Shape of the Average Cost Curves
AVC = VC/q.
But in the short-run, with only labor as an
input:
AVC = VC/q = wL/q
And since q/L = APL, then
AVC = VC/q = w/APLL
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Application Short-Run Cost Curves for a
Furniture Manufacturer
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Table 7.2 Effect of a Specific Tax of
$10 per Unit on Short-Run Costs
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Figure 7.3 Effect of a Specific Tax on
Cost CurvesC
osts
per
un
it,
$
155 8 100
q, Units per day
80
37
27
$10
$10
ACa = ACb + 10
ACb
MCb
MCa = MCb + 10
A $10.00 tax shifts
both the AVC and
MC by exactly
$10…
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Solved Problem 7.1
What is the effect of a lump-sum
franchise tax on the quantity at which a
firm’s after tax average cost curve
reaches its minimum? (Assume that the
firm’s before-tax average cost curve is
U-shaped.)
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Solved Problem 7.1
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Long-Run Costs
Fixed costs are avoidable in the long
run.
in the long F = 0.
As a result, the long-run total cost equals:
C = VC
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Input Choice
isocost line - all the combinations of
inputs that require the same (iso-) total
expenditure (cost).
The firm’s total cost equation is:
C = wL + rK.
Labor
Costs
Capital
Costs
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Input Choice (Cont).
The firm’s total cost equation is:
C = wL + rK.
We get the Isocost equation by setting fixing the
costs at a particular level:
C = wL + rK.
And then solving for K (variable along y-axis):
K = r- Lw
rC
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Table 7.3 Bundles of Labor and
Capital That Cost the Firm $100
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Figure 7.4 A Family of Isocost LinesK
, U
nits o
f ca
pita
l p
er
year
a
d
e
$100 isocost
L, Units of labor per year
$100
$1010 =
$100
$5= 20
Isocost Equation
K = r- Lw
rC
Initial ValuesC = $100w = $5r = $10
15
2.5
10
5
7.5
5
c
b
L = 5
K = 2.5
For each extra unit
of capital it uses,
the firm must use
two fewer units of
labor to hold its
cost constant.
Slope = -1/2 = w/r
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Figure 7.4 A Family of Isocost LinesK
, U
nits o
f ca
pita
l p
er
year
a
e
$150 isocost$100 isocost
L, Units of labor per year
$150
$1015 =
$100
$1010 =
$100
$5= 20
$150
$5= 30
Isocost Equation
K = r- Lw
rC
Initial ValuesC = $150w = $5r = $10
An increase in C….
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Figure 7.4 A Family of Isocost LinesK
, U
nits o
f ca
pita
l p
er
year
a
e
$150 isocost$100 isocost$50 isocost
L, Units of labor per year
$150
$1015 =
$100
$1010 =
$50
$105 =
$50
$5= 10
$100
$5= 20
$150
$5= 30
Isocost Equation
K = r- Lw
rC
Initial ValuesC = $50w = $5r = $10
A decrease in C….
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Combining Cost and Production
Information.
The firm can choose any of three equivalent approaches to minimize its cost:
Lowest-isocost rule - pick the bundle of inputs where the lowest isocost line touches the isoquant.
Tangency rule - pick the bundle of inputs where the isoquant is tangent to the isocost line.
Last-dollar rule - pick the bundle of inputs where the last dollar spent on one input gives as much extra output as the last dollar spent on any other input.
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Figure 7.5 Cost MinimizationK
, U
nits o
f capital per
hour
x
500 L, Units of labor per hour
100
q = 100 isoquant
$3,000isocost
$2,000
isocost
$1,000isocost
Isocost Equation
K = r- Lw
rC
Initial Valuesq = 100
C = $2,000w = $24r = $8
Isoquant SlopeMPL
MPK
= MRTS-
Which of these
three Isocost would
allow the firm to
produce the 100
units of output at
the lowest possible
cost?
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Figure 7.5 Cost MinimizationK
, U
nits o
f capital per
hour
y
x
z
11650240
L, Units of labor per hour
100
303
28
q = 100 isoquant
$3,000isocost
$2,000
isocost
$1,000isocost
Isocost Equation
K = r- Lw
rC
Initial Valuesq = 100
C = $2,000w = $24r = $8
Isoquant Slope
MPL
MPK
= MRTS-
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Cost Minimization
At the point of tangency, the slope of the
isoquant equals the slope of the isocost.
Therefore,
r
MP
w
MP
r
w
MP
MP
MP
MPMRTS
r
wMRTS
KL
K
L
K
L
last-dollar rule: cost is
minimized if inputs
are chosen so
that the last dollar
spent on labor adds
as much extra output
as the last dollar
spent on capital.
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Figure 7.5 Cost MinimizationK
, U
nits o
f capital per
hour
y
x
z
11650240
L, Units of labor per hour
100
303
28
q = 100 isoquant
$3,000isocost
$2,000
isocost
$1,000isocost
Initial Valuesq = 100
C = $2,000w = $24r = $8
w rMPL MPK=
MPL = 0.6q/L
MPK = 0.4q/K
=24 81.2 0.4
= = 0.05
Spending one more dollar
on labor at x gets the firm
as much extra output as
spending the same
amount on capital.
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Figure 7.5 Cost MinimizationK
, U
nits o
f capital per
hour
y
x
z
11650240
L, Units of labor per hour
100
303
28
q = 100 isoquant
$3,000isocost
$2,000
isocost
$1,000isocost
Initial Valuesq = 100
C = $2,000w = $24r = $8
w
r
MPL
MPK
MPL = 0.6q/L
MPK = 0.4q/K
= 24
8
2.5
0.13=
= 0.1
if the firm shifts one dollar from
capital to labor, output falls by
0.017 because there is less capital
but also increases by 0.1 because
there is more labor for a net gain of
0.083 more output at the same
cost….
= 0.02So …the firm should shift
even more resources from
capital to labor—which
increases the marginal product
of capital and decreases the
marginal product of labor.
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Figure 7.6 Change in Factor PriceK
, U
nits o
f ca
pita
l p
er
ho
ur
x
77500 L, Workers per hour
100
52
q = 100 isoquant
Original
isocost,
$2,000
New isocost,
$1,032
w rMPL MPK=
Minimizing Cost Rule
A decrease in w…. Initial Valuesq = 100
C = $2,000w = $24r = $8w2 = $8C2 = $1,032
v
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How Long-Run Cost Varies with Output
expansion path - the cost-minimizing
combination of labor and capital for each
output level
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Figure 7.7(a) Expansion Path
K, U
nits o
f ca
pita
l p
er
ho
ur
x
y
z
10075500 L, Workers per hour
150
200
100
Expansion path
$3,000isocost
$2,000isocost
$4,000isocost
q = 100 Isoquant
q = 200 Isoquant
q = 300 Isoquant
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Figure 7.7(b) Expansion Path and
Long-Run Cost Curve (cont’d)
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Solved Problem 7.4
What is the long-run cost function for a
fixed-proportions production function
(Chapter 6) when it takes one unit of
labor and one unit of capital to produce
one unit of output? Describe the long-
run cost curve.
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Figure 7.8 Long-
Run Cost Curves
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Economies of Scale
economies of scale - property of a cost
function whereby the average cost of
production falls as output expands.
diseconomies of scale - property of a
cost function whereby the average cost
of production rises when output
increases.
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Table 7.4 Returns to Scale and
Long-Run Costs
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Table 7.5 Shape of Average Cost
Curves in Canadian Manufacturing
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Long-Run Average Cost
In its long-run planning, a firm chooses a
plant size and makes other investments
so as to minimize its long-run cost on
the basis of how many units it produces.
Once it chooses its plant size and
equipment, these inputs are fixed in the
short run.
Thus, the firm’s long-run decision determines its
short-run cost.
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Figure 7.9 Long-Run Average Cost as the
Envelope of Short-Run Average Cost CurvesA
vera
ge c
ost, $
a
bd
e
SRAC1 SRAC2SRAC3
SRAC3LRAC
c
q2
q1
q, Output per day
10
0
12
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Application Long-Run Cost Curves in Furniture
Manufacturing and Oil Pipelines
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Application Long-Run Cost Curves in Furniture
Manufacturing and Oil Pipelines
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Application Choosing an Ink-Jet or a
Laser Printer
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Figure 7.10 Long-Run and
Short-Run Expansion Paths
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How Learning by Doing Lowers Costs
learning by doing - the productive skills
and knowledge that workers and
managers gain from experience
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Figure 7.11 Learning by Doing
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Cost of Producing Multiple Goods
economies of scope - situation in
which it is less expensive to produce
goods jointly than separately.
production possibility frontier - the
maximum amount of outputs that can be
produced from a fixed amount of input
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Figure 7.12 Joint Production