◦ from the definition of M C
MC
=
∆T V C ∆q
=
w∆L ∆q
5
• from the definition of M PL
MC
=
w M PL
◦ shape of M PL determines shape of M C
• divide T C through by q
AC = AF C + AV C
(ii) equipment leased at $10,000 per year ◦ economic cost is not $10,000 ◦ could sublease equipment (opportunity cost)
(iii) equipment purchased for $8,000 ◦ economic cost depends on decision:
TC = TFC +TVC
◦ price of labour w and price of capital is r
T V C = w × L and T F C = r × K
◦ marginal cost
MC
=
∆T C ∆q
=
∆T V C ∆q
◦ extra cost of producing one more unit of q
- decreasing LRAC → economies of scale - increasing LRAC → diseconomies of scale • typical LRAC ◦ economies of scale at low q; diseconomies of scale at high q • minimum efficient scale ◦ output level at which LAC stops falling
7
Long-run Cost • K and L are variable in the LR • long-run average cost LRAC ◦ related to SR AC ◦ example with 3 levels of K ◦ LRAC is lower envelope of SR AC • scale economies ◦ what happens to LRAC as q increases
1
• graph a typical SR production function
• marginal product of labour
M PL
=
∆q ∆L
◦ extra output from one more unit of L
◦ slope of SR production function
• what causes diseconomies of scale ◦ finite management capabilities ◦ transportation costs
• learning by doing ◦ LRAC moves downwards over time
9
◦ because T V C = wL
AV C
=
wL q
◦ from the definition of APL
AV
C
=
w APL
◦ shape of APL determines shape of AV C
6
• relationship between M C, AV C, AC ◦ M C passes through minimum of AV C ◦ M C passes through minimum of AC • SR cost curve diagram: ◦ contains all the important cost information for the firm ◦ can ignore production function • summary: ◦ SR production is subject to diminishing returns ◦ M PL is ∩-shaped ◦ M C is ∪-shaped ◦ M C passes through minimum of AV C and AC
Chapter 7 • the firm’s production decision ◦ how the firm chooses its input levels
- technology → input options - cost → cheapest option Technology • firm produces one output (q) using two inputs - capital (K) and labour (L) ◦ production function
8
• what causes economies of scale? ◦ technological reasons
- specialization and division of labour - engineering factors - automation ◦ financial reasons - quantity discounts - advertising fixed costs
- $8,000 if thinking about buying - scrap value if already bought
• accounting cost or economic cost? ◦ depends on circumstances
4
Short-run Cost
• fixed cost and variable cost
3
• more examples:
(i) firm moves into the owner’s building ◦ does not reduce cost by $24,000 ◦ owner could rent building to someone else ◦ building has an opportunity cost
Item Wages Rent Raw materials
Cost ($) 73,000 24,000 47,000
Accounting cost Owners time Economic cost
144,000 30,000
174,000
• economic owners time
• law of diminishing returns ◦ M PL will eventually decrease
• average product of labour
APL
=
q L
• plot M PL and APL for typical case ◦ relationship between APL and M PL
- M PL passes through maximum of APL
2
Cost
• economic cost v accounting cost ◦ key difference: opportunity cost ◦ often implicit (hidden)
• example: owner-operated business
q = f (L, K)
◦ maximum output for a given level of L and K • input choices depend on the time horizon ◦ short run: K is fixed, L is variable ◦ long run: K and L are variable