Chapter 6 Costs and Choice

Size: px
Start display at page:

Download "Chapter 6 Costs and Choice"

Transcription

1 Chapter 6 Costs and Choice 6.0 Preliminaries Costs of production influence the prices of goods and services, the profitability, even the survival of business firms and the structure of markets and industries. The analysis of production costs is therefore a critical topic in microeconomics. There are experts of all kinds in the business world and elsewhere who are interested in cost concepts of various types, ranging from cost accountants to production managers to industrial engineers. But recall that the economic concept of cost is opportunity cost. When economists talk about cost, they always have this concept in mind. We therefore repeat below the definition of opportunity cost from Chapter 1. DEF 1.11 The opportunity cost of (producing or consuming) one unit of good G (i.e., some good) consists of the highest-valued alternative good (or goods) that must be sacrificed in order to produce or consume that unit. The opportunity cost concept is crucial because of the fact of scarcity and the resulting need to economize, which is a basic fact of economic life and lies at the heart of economics as a subject. (REM Chapter 1.) DEF 1.11 is therefore essential for a full understanding of the economics of costs. But the definition is difficult to apply in many practical circumstances. What we need therefore is a more "operational" or practicable concept of opportunity cost which we provide through a brief preliminary analysis of firms and their profits. 6.1 Firms and Profits EXAMPLE 6.1: Mark Di Suvero is an electrical engineer who recently went into business for himself, developing and manufacturing industrial measuring devices. His small factory is located in an old building off Route 4 (which he owns). Buildings of this type rent for approximately $3,000 per month. Just before he went into business, Di Suvero 1

2 worked for an electrical equipment manufacturer at an annual salary of $80,000. He is confident that he could easily find employment at a similar salary. In addition to the building, Di Suvero has $180,000 tied up in the business, which could earn him interest of $9,000 per year if placed in a savings account or similar safe asset. In the most recent year Di Suvero's firm had revenues of $280,000. He employed three people at an average annual salary of $35,000. Furthermore, his materials purchases amounted to $28,000 while his utility bills came to $12,000. He had miscellaneous (variable) expenses of $17,000. An accountant would use Table 6.1 (called an income statement) to calculate Di Suvero's profit for the year. An economist examining this income statement would assert that for decision-making purposes the profit calculation is inadequate. (For example, if Di Suvero has to decide whether to stay in this business or not.) The economist would call the four cost items listed in Table 6.1 explicit costs. Table 6.1: Income Statement -- Di Suvero Co. Revenue $280,000 Costs Labor $105,000 Materials 28,000 Utilities 12,000 Miscellaneous 18,000 Total 163,000 Profit $117,000 DEF 6.1: (Total) explicit costs (TC x ) are monetary payments to outsiders, i.e., nonowners of the firm, for the use of factors of production (inputs) which they provide. NOTE 6.1: Explicit costs are often said to be equivalent to accounting costs. But accounting costs normally include items such as depreciation, an allowance for the "using up" of the firm's capital stock, such as buildings and equipment. This is a noncash cost of resources which are owned by the firm's owners. Nevertheless, for simplicity we will adopt the view that explicit costs are equivalent to accounting costs. Given the definition of explicit (or accounting) costs in DEF 6.1, we often call the profit calculated in the income statement above (Table 6.1) accounting profit. 2

3 DEF 6.1a: DEF 6.1a: Accounting profit (Π a ) is defined as the difference between a firm s total revenue and its total explicit costs. In symbols: Π a = TR TC x An economist looking at the income statement (Table 6.1) would point out that the resources owned by Di Suvero (including his own labor power, managerial abilities, etc.) have alternative uses. Hence by using them in his own business he gives up the opportunity to sell them (or to rent them out, etc.). The (net) revenues he forgoes this way, called implicit costs, must be included in a correct economic calculation of costs and profit. The Di Suvero Company s implicit costs are shown in Table 6.2 below. The sum of explicit and implicit costs is called economic costs. DEF 6.2: (Total) implicit costs (TC i ) are the opportunity costs (foregone earnings) of resources employed by the firm which are owned by its owners. DEF 6.3: (Total) economic costs (TC e ) are the opportunity costs of all the resources employed by the firm in its productive activities. They therefore consist of the sum of explicit and implicit costs. In symbols: TC e = TC x + TC i Table 6.2: Implicit Costs -- Di Suvero Co Rent $36,000 Interest 9,000 Wages 80,000 Total $125,000 NOTE 6.2: It is sometimes said that implicit costs are opportunity costs while explicit costs somehow are not. This is incorrect. All economic costs are opportunity costs! It is simply that the opportunity cost concept calls attention to the fact that implicit costs must be included along with explicit costs in a correct calculation of economic cost. 3

4 We called the profit concept calculated in Table 6.1 "accounting profit." (DEF 6.1a) But for decision-making purposes we are interested in economic profit. The calculation of economic profit is then straightforward. Using the data from Tables 6.1 and 6.2, we have: Economic Profit = $280,000 ($163,000 + $125,000) = $8,000. In DEF 6.4: Economic profit (sometimes called pure profit) is a surplus of revenue over economic cost and is calculated by subtracting total (economic) cost from total revenue. In symbols, (using Π e for economic profit): Π e = TR TC e other words, while Di Suvero is told by his accountant that he earned a profit last year of $117,000, "his" economist tells him that he suffered an economic loss of $8,000! To understand the thinking involved, consider the following: QUESTION 6.1: ANSWER 6.1: Assume that Di Suvero (correctly) believes that the cost and revenue data will remain at their current levels for the foreseeable future. Should he stay in this business or not? Thinking this question through carefully should lead you to conclude that the answer is "no." Call Di Suvero's revenues minus cash outlays his cash flow (CF). If he stays in this business, CF = $117,000 (i.e., his accounting profit). But if he leaves the business, rents out the building which he owns, places his remaining cash in a savings account and goes to work for someone else, CF = $125,000. (Do you see why?) Di Suvero is better off if he leaves the business! We sometimes say that if a firm has just enough revenue to cover all its costs (including its implicit costs) it is earning a normal profit. DEF 6.5: A normal profit is the minimum return to the resources owned by the owners of a firm (including their labor power or human capital) required to keep them in their present business. 4

5 NOTE 6.3 NOTE 6.4: In the corporate world the corresponding concept is called the opportunity cost of capital, since (financial) capital is the input provided by a corporation s "owners,"(i.e., its shareholders.) Normal profit, as defined here, is regarded by economists as a cost while economic profit is regarded as a surplus, over and above costs. Because of DEF 6.5, economic (or pure ) profit is sometimes also called above-normal profit. Because of this line of reasoning, implicit costs as a component of total (economic) cost will be "lurking in the shadows" so to speak in all our discussions of costs in this and subsequent chapters. 6.2 Time Perspectives Once Again: Costs in the Short-Run and Long-Run Just as in the analysis of production (Chapter 5), cost analysis depends on the time perspective being employed. If the time frame is such that at least one input must remain fixed while some other input(s) can be varied, we call this the short-run. But if instead all inputs can be varied, we call this the long-run. The inputs which can be varied we call variable inputs and those that cannot be varied we call fixed inputs. (REM: DEF 5.3 and DEF 5.4.) We use a corresponding classification of costs: variable costs, fixed costs and their sum, total costs DEF 6.6: Total variable costs (TVC) are the costs of the variable input(s) being employed in some productive activity. DEF 6.7: Total fixed costs (TFC) are the costs of the fixed input(s) being employed in some productive activity. DEF 6.8 Total cost (TC) is the sum of total fixed cost (TFC) and total variable cost (TVC). EXAMPLE 6.2: Consider the Beckman Co., which runs a simple production process in which two inputs are employed to produce one output (Q). We are examining this process over the course of one month. Assume one of 5

6 the inputs (e.g., labor) can be varied while the other (capital) cannot, perhaps because some equipment has been leased for the entire month. To produce 40 units of output requires 80 hours of labor at an hourly wage of $20 and 10 "units" of capital at a per unit rental cost of $80. (Assume these are the only relevant costs and that all opportunity costs have been properly accounted for.) Then from a short run perspective, when Q = 40, TVC = $1,600 (= $20 x 80), TFC = $800 (= $80 x 10) and TC = $2,400 (= $ $800). From a long-run perspective the distinction between variable costs and fixed costs is then simply not made. Per Unit Costs There obviously exist circumstances when we need information about costs per unit of output. The required concepts are simply a matter of arithmetic: DEF 6.9: Average variable costs (AVC) (or variable costs per unit) at some output level Q equals total variable costs at that output level divided by Q. In symbols: T VC AVC Q DEF 6.10: Average fixed costs (AFC) (or fixed costs per unit) at some output level Q equals total fixed costs divided by Q. In symbols: TFC AFC Q DEF 6.11: Average total costs (ATC) (or total costs per unit) at some output level Q equals total costs divided by Q. In symbols: ATC TC Q It obviously follows from the foregoing definitions that: STATEMENT 6.1: ATC = AVC + AFC 6

7 NOTE 6.5: NOTE 6.6: It should be obvious that the average or per unit cost concepts discussed above are meaningful only in the case of a single-product firm. (REM Ch. 5). In the case of multi- product firms, it is not always clear by what "output" to divide total cost in order to obtain "average cost." When there is no need to make a distinction between average variable and average total cost we simply talk about average cost (AC). Definitions 6.6 to 6.11 are summarized in Table 6.3. Table 6.3: Six Standard Cost Concepts Total Variable Costs (TVC) Average Variable Cost (AVC = TVC/Q) Total Fixed Costs (TFC) + Average Fixed Cost (AFC = TFC/Q) + Total Cost (TC) Average Total Cost (ATC = TC/Q) As usual in economics, we are also interested in the relevant marginal concepts. In this case this is obviously marginal cost (MC), which is defined analogously to the marginal concepts we encountered previously. In the definition below ΔTC stands for a change in (total) costs, ΔTVC for a change in (total) variable costs and ΔQ stands for a (small) change in output, usually a one-unit change. DEF 6.12: The marginal cost (MC) at some output level Q consists of the additional costs that result from the production of a small additional quantity (usually one unit) of output In symbols: ΔTC MC ΔQ ΔTVC ΔQ DEF 6.12 says that marginal cost can be calculated either as the change in total cost or as the change in total variable cost that results from a small change in output. This is obviously the case because variable cost is the only component of total cost which changes as a result of a change in output. Since the change in output for which MC is calculated is frequently a one unit change, that is, ΔQ = 1, marginal cost can also be calculated as shown in DEF 5.13 below: 7

8 DEF 6.13: The marginal cost of the nth unit of output (MC n ) in some productive activity equals the total cost when n units are produced (TC n ) minus the total cost when n 1 units are produced (TC n 1 ). In symbols: MC n = TC n TC n 1 QUESTION 6.2: ANSWER 6.2: EXAMPLE 6.3: Can a similar definition be constructed using total variable costs instead of total costs? The answer to this question is left as an exercise for the reader. DEF 6.13 can be applied as follows: In a production process where some output Q is produced we wish to calculate the marginal cost of the 17 th unit of output. (MC 17 ). We have information about the total cost of production when Q = 17 (TC 17 ) and when Q = 16 (TC 16 ). We then have: MC 17 = TC 17 TC 16 EXAMPLE 6.4: In the case of the Beckman Co. (EXAMPLE 6.2), it is easy to see that AVC = TVC/Q = $1,600/40 =$40 per unit, AFC = TFC/Q = $800/40 = $20 per unit and ATC = TC/Q = $2400/40 = $60 per unit. Alternatively, ATC can be calculated as AVC + AFC = $40 + $20 = $60 per unit. Marginal cost cannot be calculated based on the available information. But assume that Beckman's production manager knows that 41 units (instead of 40) can be produced using an additional 4 units of labor. (REM: we are examining a short-run production process in which the capital input must remain fixed while the labor input can be varied.) For the 41st unit we then have: MC 41 = 4 x $20 = $80. If instead we know that Beckman s total costs equal $2,400 when Q = 40 and $2,480 when Q = 41 it is easy to see that: MC 41 = TC 41 TC 40 = $2,480 $2400 = $ Short-Run (Total) Cost-Output Relationships The analysis of costs in microeconomics turns out to revolve around the relationship between costs and output. In other words, we try to discover how the different cost concepts we constructed in Section 6.2 are related to a firm s level of production under 8

9 different possible circumstances. It is convenient to represent this relationship by a cost function. DEF 6.14: A cost function shows the lowest cost at which different quantities of a particular good or service can be produced, given the prices of inputs and the state of technology. NOTE 6.6: DEF 6.13 states that a cost function shows the lowest cost at which different quantities of a good can be produced. This is just the mirror image of the statement in Chapter 5 that a production function shows the maximum output obtainable from a given combination of inputs (DEF 5.2). In other words we assume that efficient choices have somehow already been made in the background and the results are presented to us in the form of a cost function. Just as in the case of production functions, cost functions can be represented by tables, graphs or algebraic formulae. What we are interested in is the "shape" and "location," of a firm's cost function. To construct a cost function we need information about the physical input-output relationships embodied in production functions (Chapter 5) and the prices of inputs, assumed to be determined in input markets through the interaction of supply and demand. For simplicity we assume in this chapter that the prices of inputs are known. We can therefore think of a cost function as derived from a production function. A Simple Cost Function We begin our discussion with the simplest possible production function, one that describes a production process which employs a single variable input, say labor (L) to produce some output (Q). We assume either that no other inputs are required or that other inputs are so abundant that they can be obtained immediately at zero cost. Then clearly the law of diminishing returns does not apply and the relationship between the single input and the resulting output is linear. In symbols: Q = a x L (6.1) In EQ. 6.1 a represents the productivity of labor, i.e., the number of units (in this example, bricks) each worker is capable of producing per unit of time, e.g., per hour, day, week, etc. 9

10 EXAMPLE 6.5: The Ladrillo Co. is a small brick manufacturer located in Balenciaga. They employ simple tools and easily available materials along with labor. Each worker on average can produce 5,000 bricks per week. Then Ladrillo s production function can then be written: Q = 5,000 x L where Q represents the firm s weekly output and L the number of workers employed per week. This information can then be summarized in Table 6.5 and Figure 6.1. Table 6.5: Ladrillo Co. s Production Function (1) (2) Labor (per week) Output (bricks per week) 1 5, , , , , , ,000 Figure 6.1 TP a c b 10

11 NOTE 6.7: The production function in this example is represented by a straight line passing through the origin. It should be easy to recognize that the average product (AP) and the marginal product (MP) are (a) identical and (b) constant. Both are represented geometrically by the slope of the TP line, shown by the ratio bc/ab. So AP = MP = 5,000/1 = 5,000. To construct the firm s cost function we need one more piece of information: the weekly wage in Balenciaga. Assume the country has undergone a long period of inflation and the weekly wage is now 40,000 leo (the currency of Balenciaga). We now reason in the following obvious way: if one worker can produce 5,000 bricks per week and his weekly wage is 40,000 leo (and labor is the only input), then the total cost of manufacturing 5,000 bricks is 40,000. If two workers can produce 10,000 bricks then the total cost of manufacturing 10,000 bricks is 2 x 40,000 = 80,000 leo, etc. We summarize this information in Table 6.6 (which contains the same information as Table 6.5 with one additional column, labeled TC) and in Figure 6.2. (NOTE: in the table, Columns (2) and (3) together constitute the firm s cost function.) We can read one obvious fact from the table and the graph: to produce a higher output requires more inputs, hence it leads to higher TC. Table 6.6: Ladrillo Co.: Cost Function (1) (2) (3) Labor Output (per week) (bricks per week) TC 1 5,000 $40, ,000 80, , , , , , , , , , ,000 NOTE 6.8: The cost function in this example is represented by a straight line passing through the origin, just like the production function on which it is based. It should therefore again be simple to recognize that the average cost (AC) and the marginal cost (MC) are (a) identical and (b) constant, that is AC = MC. They are represented geometrically by the slope of the TC line, i.e., the ratio bc/ab. 11

12 Figure 6.2 a c b TC PROBLEM 6.1: SOLUTION 6.1: What is the average cost (AC) and the marginal cost (MC) implicit in Ladrillo s cost function? Using DEF 6.11 and 6.12 (and the information from either Table 6.6 or Figure 6.2) it is easy to calculate the average cost and marginal cost to be: AC = MC = 40,000/5,000 = 8 (leo/brick) A Variation on the Simple Cost Function There is a variation on our simple cost function which is often useful, for example in so-called break-even analysis which we briefly discuss in Chapter 24. We now assume that the production process we are studying employs more than one input, at least one of which is fixed and one variable. But we continue to assume that the relationship between a firm s output level and TVC is linear and can be represented graphically by a straight line passing through the origin (i.e., we ignore the law of diminishing returns). Such a pattern is often a good approximation to actual production processes and may therefore be used in back-of-an envelope calculations in production and cost analyses. The resulting cost function is then shown in Figure 6.3 below. Figure 6.3 represents an updated version of the cost function of the Ladrillo Co. We now include total fixed costs (TFC = 50,000 leo).the TFC line is a straight line parallel to the horizontal axis total fixed costs remain the same at all output levels by definition. The TVC line has the same look as before. We obtain the total cost line by adding the TFC and TVC lines vertically. Note therefore that at any point the vertical distance between 12

13 the TC and TVC lines equals TFC. (See the discussion below of the cost function of the VB&B Co.) Figure 6.3 TC TVC TFC A Second Cost Function In Chapter 5 we introduced the production function of the Village Belt & Buckle Co. (VB&B), a manufacturer of leather belts. Their production function took the following form (EQ 5.1): Q A KL (5.1) We assumed that VB&B needed only labor and equipment to produce its output and that in the short run K (equipment, or capital) is fixed. For convenience we further assumed that K = 1 and A = 100. We then proceeded to construct a graph of this production function, which is repeated below. (Figure 5.1) We wish to construct VB&B s (short-run) cost function using the information contained in its production function. As before, in our discussion of Ladrillo s simple cost function, we need to know the prices of the inputs employed by the firm, but now there are two inputs: one fixed and one variable. Assume the rental cost of the equipment employed by the company is $40,000, so we have TFC = $40,000. Assume also that we 13

14 are studying VB&B s production process over a period of time such that labor cost per worker is $12,000. We are now able to construct Table 6.7, which contains VB&B s cost Figure 5.1 TP function. Column (1) shows the amounts of the variable input (labor) employed, Column (2) shows the resulting output in increments of 100 and Column (3) shows the total variable cost associated with each output level. Table 6.7: VB&B Co. (Variable) Cost Function (1) (2) (3) Labor Output (belts) TVC $12, , , , , , ,000 QUESTION 6.3: How do we know that 9 workers can produce 300 belts and 25 workers are needed to produce 500 belts? 14

15 ANSWER 6.3: Consider the production function given in EQ 5.1 again. If A = 100, K = 1 and L = 9 we have: Q 100 1x Verifying that an output of 500 belts requires 25 workers is left as an exercise for the reader. One can think of Table 6.7 in the following way: columns (1) and (2) constitute VB&B s production function and columns (2) and (3) its (short-run variable) cost function. How do we get from columns (1) and (2) to column (3) which shows the firm s total variable costs at different output levels? Note that when one worker is employed she produces 100 units and the cost of employing her is $12,000. Since labor is the only variable input DEF 6.6 tells us that TVC at Q = 100 is $12,000. Similarly, when L = 4 we have Q = 200 and TVC at that level of output is 4 x $12,000 = $48,000. We are able to complete the rest of the Column (3) in a similar fashion. To complete our tabular presentation of VB&B s cost function we insert two additional columns showing the firm s fixed costs and total costs. Table 6.8: VB&B Co. (Total) Cost Function (1) (2) (3) (4) Output (belts) TVC TFC TC 0 0 $40,000 $40, $12,000 40,000 52, ,000 40,000 88, ,000 40, , ,000 40, , ,000 40, , ,000 40, , ,000 40, ,000 Figure 6.4 is a graphic representation of VB&B s total cost function, which is constructed by plotting the data from Table 6.8. Output is shown on the horizontal axis and total costs and their components on the vertical axis. Notice the following facts in Figure 6.4 (as well as Table 6.8): (a) Production costs increase as output increases. (The TVC and TC curves have positive slopes.) The reason is obvious: higher production levels require higher levels of input use which leads to higher TVC (and TC). (REM: our discussion of the simple cost function and Figure 6.2.) 15

16 Figure 6.4 TC TVC c a b TFC (b) (c) (d) Total variable costs (and therefore total costs) are increasing at an increasing rate as output increases. (The TVC and TC curves are becoming steeper as we move to the right, i.e., their slopes are increasing.) This is the mirror image of the fact that in Figure 5.1 (VB&B s production function) output is rising, but at a decreasing rate (The slope of the total product (TP) curve is decreasing.) This point will be discussed further in several places below. The TFC curve is a horizontal straight line; i.e., fixed costs are the same at all output levels. This of course is true by definition. The TC curve is obtained by vertically adding up the TVC and TFC curves. Since by DEF 6.8 we have TC = TVC + TFC, we obtain the TC curve by shifting the TVC curve up by the amount of total fixed costs. (Hence the vertical distance between the TVC and TC curves equals TFC.) Some Geometry of the (Total) Cost Function We can use the information contained in the total cost function to determine marginal and average costs. Specifically we can ascertain the geometric representation of MC, AVC and ATC, using the same approach we did in Chapter 5 in our discussion of the marginal and average product. Consider Figure 6.4 again. We want to calculate the (approximate) marginal cost in the interval between 500 and 600 units of output. Note that when 500 units are produced, TVC is given by the vertical distance from the horizontal axis to point a. (TVC = $300,000). When Q= 600, TVC is given by the vertical distance from the horizontal axis to point c. (TVC = $432,000; see the arrow pointing to a point close to $400,000 in the 16

17 graph; see also Table 6.8). The change in TVC is given by the line segment bc. (ΔTVC = $432,000 $300,000 = $132,000) The change in output (ΔQ) is given by the line segment ab. (ΔQ = = 100) Since MC = ΔTC/ΔQ = ΔTVC/ΔQ, it is shown in the graph by the ratio bc/ab, which represents (approximately) the slope of the TVC curve in the interval. (So MC in the interval = $132,000/100 = $1,320) We repeat our conclusion in the statement below: STATEMENT 6.2 Marginal Cost (MC) is represented geometrically by the slope of the total variable cost (TVC) curve. NOTE 6.9: MC can be calculated either as MC = ΔTVC/ΔQ or as MC = ΔTC/ΔQ. So it should be obvious that MC is also represented geometrically by the slope of the TC curve. Next we want to calculate AVC at some output level, say when Q = 600. We know that in Figure 6.4 TVC when Q = 600 is shown by the vertical distance between the horizontal axis and point c. The output level is of course shown by the horizontal distance from the origin to the point 600. Since AVC = TVC/Q, the ratio of the vertical distance to the horizontal distance represents AVC. But this ratio is also the slope of the straight line from the origin to point c. So the slope of such a line (called a ray REM Chapter 5) is the geometric representation of average variable cost. We repeat our conclusion in the statement below: STATEMENT 6.3 Average Variable Cost (AVC) at some output level Q is represented geometrically by the slope of the ray to the TVC curve at that output level. PROBLEM 6.2: What is VB&B s AVC at an output level of 600? SOLUTION 6.2: NOTE 6.10: Since TVC = $432,000 when Q = 600 (see arrow along the vertical axis), ATC = $432,000/600 = $720 If an AVC of $720 per belt bothers you, you can imagine that a unit of output of the VB&B Co. means a dozen or a gross of belts (A gross equals a dozen dozens!) A similar construction as above would lead us to STATEMENT 6.4: STATEMENT 6.4 Average Total Cost (ATC) at some output level Q is represented geometrically by the slope of a ray to the TC curve at that output level. 17

18 QUESTION 6.4: ANSWER 6.4: Why does the TVC curve in Figure 6.4 become steeper as more output is produced? We now know that this question can be asked in two other (equivalent) ways. (1) Why is the slope of the TVC curve increasing and (2) why is MC rising as output increases? We said above that this is the mirror image of the fact that the total product curve becomes less steep as more of a variable input is employed. In other words, the slope of the TP is decreasing, which means that the marginal product is falling (due to the law of diminishing returns). But what is the connection? Consider the table below. It shows a brief excerpt from a production function. Assume it represents the weekly output of the Newton Co., a small manufacturer in New Jersey, whose only variable input is labor and the weekly wage (w) is $100. Table 6.9 (1) (2) (3) (4) Labor (L) Output (Q) Marginal Product Marginal Cost Of Labor (MPL) (MC) $ Note that MPL (Column (3)) is decreasing as more labor is employed, i.e., the production function embodies diminishing returns. Now assume that Newton s manager is considering increasing employment from two to three workers. Clearly output will increase from 70 units to 90 units, i.e., the marginal product of the 3 rd worker, MPL 3 = 20. We know that: ( ) In other words, since ΔL = 1, the marginal product of an additional worker is simply the extra output (ΔQ) produced by that worker. We want to calculate the firm s marginal cost in the interval between Q = 70 and Q = 90. We know that: ( ) 18

19 Why are we replacing ΔTVC with w, (the weekly wage) in EQ (6.3)? Because the extra output is produced by an additional worker during one week and the weekly wage is $100. (REM: labor is the only variable input in this example.) So the change in TVC is simply the wage that must be paid to the additional worker. Why are we replacing ΔQ with MPL, the marginal product of labor? Because we found earlier that when ΔL = 1 then MPL and ΔQ are equivalent. We assume that the weekly wage (w) is constant since it is determined by market forces outside the control of the firm. We therefore conclude that marginal cost and marginal product are inversely related: if marginal product falls, marginal cost increases, and vice versa. This can also be seen from columns (3) and (4) in Table 6.9. Note that as the employment of labor increases (and therefore output increases) the MP falls (due to the law of diminishing returns) but marginal cost rises. (This also explains why the TP curve becomes less steep while the TVC curve becomes steeper as output increases.) We repeat our conclusion in the statement below: STATEMENT 6.5 Marginal Product (MP) and Marginal Cost (MC) are inversely related. One More (and last!) Cost Function In Chapter 5 we introduced a production function in which the marginal product of labor (MPL) first increases, reaches a maximum and then decreases. In other words, the law of diminishing returns (LDR) in this production process sets in only after several units of a variable input are being employed. We wish to analyze the cost function associated with a production function of this type. In Table 6.10 we summarize the production and cost situation of the Bridgeton Co., a small provider of cleaning services. It uses a limited amount of equipment as well as labor to produce its output. Columns (1) and (2) constitute its (short-run) production function and in Column (3) we calculate the firm s MPL. As can be easily seen, MPL at first increases, reaches a maximum when L = 4 and then decreases. This is also shown in Figure 6.5, where output at first increases at an increasing rate (the total product (TP) curve is becoming steeper), then there is a turning point where diminishing returns set in and beyond that point the TP curve increases at a decreasing rate, i.e., the LDR again is in effect. We want to construct the Bridgeton Co. s total cost function based on the information contained in its (short-run) production function. But we want the firm s output (and corresponding variable costs) to be shown at even intervals, for example in intervals of 19

20 10, as shown in Column (5) of Table We obtain the associated (variable) input requirement by interpolation. For example, we know from the firm s production function that if one worker is employed the resulting output is 10 units. When two Table 6.10 Bridgeton Co. -- Production and (Total) Cost Functions (1) (2) (3) (4) (5) (6) (7) (8) L Q MPL L Q TVC TFC TC $300 $ $ , , , , , , , workers are employed the resulting output is 21 units. So to produce 20 units requires an amount of labor somewhere between one and two units (but closer to two). Using some laborious (but not very interesting) arithmetic we find that to produce 20 units of output requires (approximately) 1.90 units of labor. Using this approach we are able to calculate the amounts of labor required to produce 20, 30,, 120 units of output. The results are shown in Column (4). To complete the construction of the Bridgeton Co. s cost function we need two more pieces of information: the price of the variable input (i.e., the wage rate) and the level of fixed costs. Assume we are studying the firm s production process over a time period such that the wage rate is $110. Then we are able to complete the TVC column in Table 6.10 (Column (6)). For example, when the output level is 40 units the labor requirement is 3.54 units and TVC = 3.54 x $110 = $389 (since labor is the only variable input). In the same way we can complete the rest of Column (5). We also obtain information that the fixed costs of the firm equal $300, so we are able to add the TFC column (Column (7)) and the TC column (Column (8)). Note that columns (5), through (8) together constitute the Bridgeton Co. s short-run (total) cost function. We plot the resulting information in a graph (Figure 6.6) with output shown on the horizontal axis and total variable costs (measured in dollars) on the vertical axis. 20

21 Figure 6.5 TP Diminishing returns set in Figure 6.6 TVC f Diminishing returns set in d e a c b Some More Geometry of the (Total) Cost Function REM 6.1: Marginal cost (MC) is represented geometrically by the slope of the TVC curve. (STATEMENT 6.2) 21

22 Average variable cost (AVC) is represented geometrically by the slope of a ray to the TVC curve. (STATEMENT 6.3) Marginal product and marginal cost are inversely related. (STATEMENT 6.5) We saw that the three statements in REM 6.1 apply to the cost functions we discussed previously, including that of the VB&B Co. (Figure 6.4). It should not be surprising that they also apply to the (total variable) cost function of the Bridgeton Co. shown in Figure 6.6. Consider the interval along the horizontal axis between 40 and 50 units of output. ΔTVC is shown by the (vertical) line segment bc. The change in output (ΔQ) is of course shown by the distance from 40 to 50 or by the (horizontal) line segment ab. The ratio bc/ab., which is an (approximate) measure the slope of the TVC curve, gives a good approximation of MC in this interval. PROBLEM 6.3: For the Bridgeton Co., calculate the (approximate) MC in the interval between 40 and 50 units of output. SOLUTION 6.3: We know from Table 6.10, Columns (4) and (5) that ΔTVC = $476 $389. = $87. ΔQ = = 10. Hence MC = $87/10 = $8.70. Next, consider the interval between 100 and 110 units of output. ΔTVC is shown by the line segment fg. The change in output (ΔQ) is shown by the line segment ef. The ratio fg/ef., i.e., the slope of the TVC curve in this interval again gives a good approximation of MC in the interval. It is obvious to the naked eye that the TVC curve is steeper in the second interval than in the first. PROBLEM 6.4: SOLUTION 6.4: Calculate the MC in the interval between 90 and 100 units of output. The solution to this problem is left as an exercise for the reader. A glance at FIG 6.6 and the solutions to PROBLEM 6.3 and PROBLEM 6.4 reveal the following: in the interval between the origin and an output level of a little less than 50 units the TVC curve is becoming less steep (its slope is decreasing); we conclude, based on REM 6.1, that MC is falling. Note the arrow pointing to a point on the TVC curve with the caption diminishing returns set in. At output levels above that level the TVC curve is becoming steeper (its slope is increasing); we conclude that MC is rising. We summarize these conclusions in STATEMENT 6.6 below: 22

23 STATEMENT 6.6: The TVC curve derived from a production function in which MP at first increases, then diminishing returns set in and the marginal product decreases (as in Figure 6.5), has an inverted S shape: at first its slope falls, reaches a turning point and then rises. The turning point corresponds to the point on the production function where diminishing returns set in. Figure 6.7 A Simplified TVC Curve $ d a b c 0 Q 1 Q 2 Q 3 Q 4 Output (Q) FIG 6.7 shows a simplified version of a TVC curve which makes it easier to see its inverted-s shape. Note that between the origin and an output level of Q 3, the slope of the TVC curve is declining (it is becoming less steep) and at output levels higher than Q 3 the slope is increasing (the TVC curve is becoming steeper.). Diminishing returns set in at an output level of Q 2 or point b on the TVC curve. QUESTION 6.5: ANSWER 6.5: Why do the TVC curves in Figures 6.6 and 6.7 have the shape that they do (as summarized in STATEMENT 6.6)? Because they are the mirror images of the production function(s) from which they are derived. For example, consider the production function (TP curve) shown in Figure 6.5. Output at first increases at an increasing rate as the amount of the variable input is increased. In 23

24 Total Costs ($) other words, MP is rising (for reasons discussed in Chapter 5, Section 5.x). Since MP and MC are inversely related (STATEMENT 6.5) the corresponding segment of the TVC curve is rising at a decreasing rate. Then the point is reached where diminishing returns set in (both on the TP curves and the TVC curves). Now MP is falling, MC is rising and TVC is increasing at an increasing rate (The TVC curve is becoming steeper). We complete our analysis of (short-run) total cost-output relationships by depicting in a single graph all the components of total cost from Table 6.10, Columns (5) (8), i.e., total variable cost, total fixed cost as well as total cost. (See Figure 6.8 below). Figure 6.8 Total Costs, Bridgeton Co TC TVC TFC Output (Q) We are now familiar with all the elements of this graph: TFC is shown as a horizontal straight line since by definition fixed costs remain the same at all levels of production, the TVC curve is identical to the one plotted in FIG 6.6 and we obtain the TC curve by adding up the TFC and TVC curves, i.e., by shifting the TVC curve vertically by the amount of fixed cost. Everything we said about the TVC curve in this section can also be said about the TC curve: the slope of the TC curve in an interval represents MC in that interval; ATC is depicted by the slope of a ray to the TC curve and the TC curve has an inverted S shape. 24

25 STATEMENT 6.7: Inverted-S shaped TVC and TC curves are more general than the other forms we discussed previously. This is true because in many productive processes diminishing returns set in only after some amount of variable input(s) is employed. Hence this is the form we will most frequently use in subsequent discussions. 6.4 Short-Run (Average) Cost-Output Relationships We also need to examine average or per unit cost-output relationships. Consider Table Columns (2) (4) contain the same data as Columns (6) (8) of Table Using DEF 6.9, through DEF 6.12; we calculate AFC, AVC, ATC and MC and show the results in Columns (6) (8). The resulting data are plotted in FIG 6.9 on page 27. Table 6.11: Bridgeton Co.: Total and Unit Costs (1) (2) (3) (4) (6) (5) (7) (8) Q TVC TFC TC AVC AFC ATC MC 0 0 $300 $ $ $ $41.00 $ , , , , , , , , PROBLEM 6.5: SOLUTION 6.5: Using the data from Table 6.11, calculate ATC when Q = 70 units. Since TC = $971 when Q = 70, ATC = $971/70 = $13.87/unit. 25

26 PROBLEM 6.6: Using the data from Table 6.11, calculate MC between Q = 70 and Q = 80. SOLUTION 6.6: Since TC = $971 when Q = 70 and TC = $1,082 when Q = 80, we have: Notice the following facts in Figure 6.9: (a) (b) (c) The simplest fact is that the AFC curve is continuously declining. This is simply a matter of arithmetic: as total fixed cost is spread over a larger output level, fixed cost per unit, i.e., AFC, continuously declines. The AVC curve declines, reaches a minimum at an output level of (approximately) 60 units and then begins to rise. Why does the AVC curve have a U-shape? Think of the geometry of the TVC curve as depicted in Figure 6.7. We know that AVC is represented geometrically by the slopes of rays drawn to the TVC curve. Imagine that as you move to the right (i.e., output increases) rays are drawn to corresponding points on the curve. As output increases from 0 to 0Q 1 to 0Q 2 to 0Q 3 the slopes of those rays will at first decrease, reach a minimum and then increase. The result is the U-shaped AVC curve. The MC curve declines, reaches a minimum between 40 and 50 units of output and then continuously increases. This is again the mirror image of the fact that marginal product increases at first, reaches a maximum and then decreases (because of the law of diminishing returns) and the fact that MP and MC are inversely related (REM STATEMENT 6.5). REM 6.2: In Section 6.3 we discussed the production function of the Bridgeton Co. and in Chapter 5 we examined the total product, average product and marginal product curves of the Horizon Co. (Figures 5.4 and 5.5) which exhibit this pattern: MP at first increases, reaches a minimum and then falls. (d) The ATC curve is also U-shaped. Since ATC = AVC + AFC, the ATC curve is constructed by simply summing up the AVC and AFC curves. So the vertical distance between the ATC and AVC curves at any point equals AFC at that output level. QUESTION 6.6: ANSWER 6.6: The vertical distance between the ATC and AVC curves is becoming smaller. Why? The answer to this question is left as an exercise for the reader. 26

27 Figure 6.9 MC ATC AVC TFC Figure 6.10 Marginal Cost and Average Variable Cost MC AVC (e) The MC curve crosses both the AVC and ATC at their minimum points. This is fundamentally an arithmetic fact but it has important economic consequences. To discuss this matter we will use Figure 6.10 which shows only the MC and AVC curves. This will simplify our discussion, but the same logic can be applied to the MC and ATC curves. 27

28 NOTE 6.11: Our discussion is brief since we dealt with the same issue in Chapter 5, Section 5.8. In Figure 6.10, at output levels a little below 10 units marginal cost is less than average variable cost (MC<AVC) so AVC falls. At output levels above 10 units MC>AVC so AVC rises. Hence MC = AVC when AVC is at its minimum, which is another way of saying that the MC curve crosses the AVC curve at its lowest point. This completes our discussion of (short run) total and unit costs These cost concepts constitute the building blocks for subsequent analyses of long-run costs, market structure and a number of other important topics. 6.5 Costs from a Long-Run Perspective According to DEF 5.4, from a long run perspective all inputs are variable. That is, since there is enough time to vary the amounts of all inputs employed in a production process, the distinction between variable and fixed inputs and variable and fixed costs does not apply. In this section we construct a long-run average cost curve (LRAC) which depicts a firm s average cost of production from such a long run perspective. Constructing the Long Run Average Cost Curve EXAMPLE 6.6: Consider the Anodyne Co., a medium-size manufacturer of specialty chemicals. They are in the early stages of a planning process which they hope will culminate in the construction of a new plant. Since within the limits of current technology they could build a plant of any size, it is correct to think of this as a long run problem. (REM: we usually assume that the capital input, i.e., the plant, is fixed in the short run.) At this point they are uncertain about the size of the plant they wish to build. So they ask the appropriate specialists to prepare some sketches of three possible plant sizes: small, medium and large. Then with each possible plant size there is associated a set of short-run cost curves. Why short-run? Because once a plant is built there is again a fixed input, namely the plant itself. So in thinking about the problem the firm s managers should picture themselves as being back in the world of the short run! In Figure 6.11 we show the short run average cost curves (SRAC) associated with each of the three possible plant sizes. 28

29 Figure 6.11 $/Q a SRAC 1 b e f SRAC 2 c SRAC 3 d 0 1,000 2,000 Which of these three possible plants should be built? The answer depends on the output the firm s managers believe they can profitably produce and sell. If they expect to produce an output level in the range from 0 to 1,000 they will (should) build plant number 1 with short run average cost curve SRAC 1. Similarly, if they expect to produce an output level in the range from 1,000 to 2,000 they should build plant number 2 with short run average cost curve SRAC 2 and if they expect to produce an output level higher than 2,000 they should build plant number 3 with short run average cost curve SRAC 3. Why? Imagine instead that they end up producing 1,300 units (see arrow along the horizontal axis) but mistakenly built plant number 1 (with SRAC 1 ). Then they clearly will have higher average costs of production than if they had done the right thing and built plant number 2. If they had built plant number 2 their average cost of production would be shown by the vertical distance from the horizontal axis to point e on SRAC 2 but because of their mistake their average cost of production is shown by the vertical distance from the horizontal axis to point f. We are now able to construct the Anodyne Co. s long run average cost curve (LRAC), i.e., a curve which shows the firms average cost of production from a long run point of view. Long run point of view here means that they are able to build a plant of any size, within some reasonable range. We do this by piecing together parts of the three 29

30 SRAC curves in Figure For output levels between 0 and 1,000 they would build plant size number 1 and we take a piece of SRAC 1. For output levels between and 2,000 they would build plant size number 2 and we take a piece of SRAC 2 and so on for plant size number 3. We end up with the odd-looking curve going from a to b to c to d. We can next imagine that there are actually many possible plant sizes that the company could build, not just three as in the previous example. This is shown in Figure 6.12 below. We show seven possible plant sizes, but theoretically there could be many more so that the SRAC curves would be dense in the diagram. The resulting LRAC curve would then be a smooth U-shaped or bowl-shaped envelope just touching each of the (many) SRAC curves, as shown in Figure Figure 6.12 $/Q SRAC 1 SRAC 7 LRACC 0 Q MES Output (Q) Economies of Scale Diseconomies of Scale Economies and Diseconomies of Scale We said above that the LRAC curve is an envelope that just touches (is tangent to in the language of geometry) all the SRAC curves that are associated with different 30

31 possible plant sizes. But we have said nothing so far about the U-shape or bowl shape of the LRAC curve. This results from our arbitrary placement of the SRAC curves in such a way that at first they shift down, reach a low point and then begin to shift up as output increases. To explain this aspect of the LRAC curve we first we have to introduce some terminology. DEF 6.15 In any productive activity economies of scale occur if (longrun) average costs of production decrease as the scale of production (or the level of production) increases. DEF 6.16: In any productive activity minimum efficient scale occurs at the lowest output level at which (long run) average costs of production are at their minimum. DEF 6.17: In any productive activity diseconomies of scale occur if (long run) average costs of production increase as the scale of production (or the level of production) increases. Note that in Figure 6.12, the Anodyne Co. s productive process exhibits economies of scale in the range between 0 and the output level marked Q MES, (since the LRAC curve slopes downward as output increases), diseconomies of scale at output levels larger than Q MES, (since the LRAC curve slopes upward as output increases) and the output level where the LRAC curve reaches its minimum is marked Q MES where MES stands for minimum efficient scale. NOTE 6.11: In many places you can find the following statement Economies of scale result from the fact that fixed costs are spread over more units as the output level increases. No! Economies of scale (and diseconomies of scale) refer to long-run average costs, not short-run average costs. The fact that as a matter of arithmetic AFC falls as output increases (partly) explains the U-shape of the short -run ATC curve. (REM Section 6.4) Since in the long run all 31

32 costs are variable we must look for an explanation for the existence of economies of scale elsewhere. Why Are There Economies of Scale? Increase in the Degree of Specialization of Labor Imagine a productive activity in which 100 workers are employed along with $1 million worth of capital to produce some output, Q. Then, the amounts of both labor and capital are doubled. It is unlikely that the 200 workers will perform the same tasks in the same way as before. Instead tasks will be rearranged (subdivided) and different kinds of equipment will be employed. There will be increased specialization of both inputs, but especially of labor. We say that the division of labor will increase. (REM Chapter 1) This leads to a rise in productivity through learning by doing, (workers become more skilled at their tasks), time saved in switching between tasks, etc. Since an increase in productivity is equivalent to a decrease in (average) costs, the LRAC curve slopes downward. Specialization in Management A small firm (plant) may have to employ managers who are generalists, that is, they deal with all the issues facing a business: issues concerning finance, marketing, human resources, etc. In contrast, a large plant is able to employ managers who are specialists in a particular discipline and thus are able to perform their tasks more effectively. This again enhances the productivity of the enterprise and lowers (long-run average) costs. Indivisible ( Lumpy ) Inputs Indivisible (sometimes called lumpy ) inputs are inputs (often pieces of capital equipment) which cannot be used economically at output levels below some minimum. EXAMPLE 6.7: Imagine a factory belonging to the North America Automobile Co. (NAAC) which manufactures car bodies. Its engineers have developed a large machine which stamps out a car body in a single step. Clearly, developing, building (and using!) such a machine is only feasible at large output levels, say if 50,000 car bodies per month are produced. At output levels of, say, 10,000 car bodies much less automated equipment has to be employed. If the plant belonging to NAAC actually produces 50,000 bodies per month it will have a cost advantage compared to the plant producing only 10,000, a cost advantage which shows up in the form of lower LRAC. 32

Mr Sydney Armstrong ECN 1100 Introduction to Microeconomics Lecture Note (6) The costs of Production Economic Costs

Mr Sydney Armstrong ECN 1100 Introduction to Microeconomics Lecture Note (6) The costs of Production Economic Costs Mr Sydney Armstrong ECN 1100 Introduction to Microeconomics Lecture Note (6) The costs of Production Economic Costs Costs exist because resources are scarce, productive and have alternative uses. When

More information

The Production and Cost

The Production and Cost The Production and Cost The Role of the Firm l The firm is an economic institution that transforms factors of production into consumer goods. It l Organizes factors of production. l Produces goods and

More information

Notes on Chapter 10 OUTPUT AND COSTS

Notes on Chapter 10 OUTPUT AND COSTS Notes on Chapter 10 OUTPUT AND COSTS PRODUCTION TIMEFRAME There are many decisions made by the firm. Some decisions are major decisions that are hard to reverse without a big loss while other decisions

More information

In the last session we introduced the firm behaviour and the concept of profit maximisation. In this session we will build on the concepts discussed

In the last session we introduced the firm behaviour and the concept of profit maximisation. In this session we will build on the concepts discussed In the last session we introduced the firm behaviour and the concept of profit maximisation. In this session we will build on the concepts discussed previously by examining cost structure, which is a key

More information

Production and Cost Analysis I

Production and Cost Analysis I CHAPTER 12 Production and Cost Analysis I Production is not the application of tools to materials, but logic to work. Peter Drucker McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All

More information

The Theory and Estimation of Cost. Tools for Today s Decision Makers, 4/e By Paul Keat and Philip Young

The Theory and Estimation of Cost. Tools for Today s Decision Makers, 4/e By Paul Keat and Philip Young The Theory and Estimation of Cost Chapter 8 Managerial Economics: Economic Managerial Economics: Economic Tools for Today s Decision Makers, 4/e By Paul Keat and Philip Young The Theory and Eti Estimation

More information

Module 55 Firm Costs. What you will learn in this Module:

Module 55 Firm Costs. What you will learn in this Module: What you will learn in this Module: The various types of cost a firm faces, including fixed cost, variable cost, and total cost How a firm s costs generate marginal cost curves and average cost curves

More information

Production and Cost Analysis I

Production and Cost Analysis I CHAPTER 12 Production and Cost Analysis I Production is not the application of tools to materials, but logic to work. Peter Drucker McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All

More information

Chapter 4 Production, Costs, and Profit.notebook. February 03, Chapter 4: Production, Costs, and Profits Pages

Chapter 4 Production, Costs, and Profit.notebook. February 03, Chapter 4: Production, Costs, and Profits Pages Chapter 4: Production, Costs, and Profits Pages 91 112 business an enterprise that brings individual, financial resources, and economic resources together to produce a good or service for economic gain

More information

OUTPUT AND COSTS. Chapter. Key Concepts. Decision Time Frames

OUTPUT AND COSTS. Chapter. Key Concepts. Decision Time Frames Chapter 10 OUTPUT AND COSTS Key Concepts Decision Time Frames Firms have two decision time frames: Short run is the time frame in which the quantity of at least one factor of production is fixed. Long

More information

Chapter 7 Producers in the Short Run

Chapter 7 Producers in the Short Run Chapter 7 Producers in the Short Run 7.1 What are Firms? Organisation of Firms 1) Single proprietorship Has one owner who is personally responsible for the firm s actions and debts 2) Ordinary partnership

More information

Going Back To School. Meet Sam

Going Back To School. Meet Sam Going Back To School Meet Sam Graduating Class of 12 Not a single callback for an interview Decision to go back to school Joined millions of students Why? The Costs of Production Chapter 9 Explicit Costs

More information

Classnotes for chapter 13

Classnotes for chapter 13 Classnotes for chapter 13 Chapter 13: Very important Focuses on firms production and costs Examines firm behavior in more detail (previously we simply looked at the supply curve to understand firm behavior)

More information

Which store has the lower costs: Wal-Mart or 7-Eleven? 2013 Pearson

Which store has the lower costs: Wal-Mart or 7-Eleven? 2013 Pearson Which store has the lower costs: Wal-Mart or 7-Eleven? Production and Cost 14 When you have completed your study of this chapter, you will be able to 1 Explain and distinguish between the economic and

More information

5 FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

5 FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY 5 FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY The s of Production 1 Copyright 2004 South-Western The Market Forces of Supply and Demand Supply and demand are the two words that economists use most often.

More information

#20: & # 8, 9, 10) 7 P # 2&3 HW:

#20: & # 8, 9, 10) 7 P # 2&3 HW: AGENDA Tues 10/6 QOD #20: Caution! Curves Ahead Law of Diminishing Marginal Returns Costs of Production (Review HW Q#1,2,5,6) Short & Long Run (Q # 8, 9, 10) Partner Practice Ch 7 P # 2&3 HW: Prep for

More information

Chapter 11. Microeconomics. Technology, Production, and Costs. Modified by: Yun Wang Florida International University Spring 2018

Chapter 11. Microeconomics. Technology, Production, and Costs. Modified by: Yun Wang Florida International University Spring 2018 Microeconomics Modified by: Yun Wang Florida International University Spring 2018 1 Chapter 11 Technology, Production, and Costs Chapter Outline 11.1 Technology: An Economic Definition 11.2 The Short Run

More information

Week 5: The Costs of Production. 31 st March 2014

Week 5: The Costs of Production. 31 st March 2014 Week 5: The Costs of Production 31 st March 2014 WHAT ARE COSTS?! According to the Law of Supply:! Firms are willing to produce and sell a greater quantity of a good when the price of the good is high.!

More information

AP Microeconomics Chapter 8 Outline

AP Microeconomics Chapter 8 Outline I. Learning Objectives In this chapter students should learn: A. Why economic costs include both explicit (revealed and expressed) costs and implicit (present but not obvious) costs. B. How the law of

More information

The Market Forces of Supply and Demand

The Market Forces of Supply and Demand Theory of the Firm The Market Forces of Supply and Demand Supply and demand are the two words that economists use most often Supply and demand are the forces that make market economies work. Modern microeconomics

More information

Cost schedules include the market value of all resources used in the production process.

Cost schedules include the market value of all resources used in the production process. By the end of this learning plan, you will be able to: Relate factor markets to production Assess the role price plays in a market economy Use marginal (Cost-Benefit) analysis in decision-making Cost schedules

More information

Lecture 10. The costs of production

Lecture 10. The costs of production Lecture 10 The costs of production By the end of this lecture, you should understand: what items are included in a firm s costs of production the link between a firm s production process and its total

More information

Syllabus item: 42 Weight: 3

Syllabus item: 42 Weight: 3 1.5 Theory of the firm and its market structures - Production and costs Syllabus item: 42 Weight: 3 Definition: Total product (TP): The total output that a firm produces, using its fixed and variable factors

More information

Production and Costs. Bibliography: Mankiw and Taylor, Ch. 6.

Production and Costs. Bibliography: Mankiw and Taylor, Ch. 6. Production and Costs Bibliography: Mankiw and Taylor, Ch. 6. The Importance of Cost in Managerial Decisions Containing costs is a key issue in managerial decisionmaking Firms seek to reduce the number

More information

Decision Time Frames Pearson Education

Decision Time Frames Pearson Education 11 OUTPUT AND COSTS Decision Time Frames The firm makes many decisions to achieve its main objective: profit maximization. Some decisions are critical to the survival of the firm. Some decisions are irreversible

More information

Short-Run Costs and Output Decisions

Short-Run Costs and Output Decisions Semester-I Course: 01 (Introductory Microeconomics) Unit IV - The Firm and Perfect Market Structure Lesson: Short-Run Costs and Output Decisions Lesson Developer: Jasmin Jawaharlal Nehru University Institute

More information

To do today: short-run production (only labor variable) To increase output with a fixed plant, a firm must increase the quantity of labor it uses.

To do today: short-run production (only labor variable) To increase output with a fixed plant, a firm must increase the quantity of labor it uses. To do today: short-run production (only labor variable) To increase output with a fixed plant, a firm must increase the quantity of labor it uses. Short-run production: only labor variable To increase

More information

2012 Pearson Addison-Wesley

2012 Pearson Addison-Wesley 11 OUTPUT AND COSTS What do General Motors, PennPower, and Campus Sweaters, have in common? Like every firm, They must decide how much to produce. How many people to employ. How much and what type of

More information

Chapter 9. Businesses and the Costs of Produc2on

Chapter 9. Businesses and the Costs of Produc2on Chapter 9 Businesses and the Costs of Produc2on Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Economic

More information

ECON 101 Introduction to Economics1

ECON 101 Introduction to Economics1 ECON 101 Introduction to Economics1 Session 10 Cost Concept Lecturer: Mrs. Hellen A. Seshie-Nasser, Department of Economics Contact Information: haseshie@ug.edu.gh College of Education School of Continuing

More information

Short-Run Costs and Output Decisions

Short-Run Costs and Output Decisions Chapter 8 Short-Run Costs and Prepared by: Fernando & Yvonn Quijano 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair Short-Run Costs and 8 Chapter Outline Costs in the

More information

The Costs of Production

The Costs of Production The Costs of Production PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University 1 What are Costs? Total revenue = amount a firm receives for the sale of its output Total cost = market

More information

Costs: Introduction. Costs 26/09/2017. Managerial Problem. Solution Approach. Take-away

Costs: Introduction. Costs 26/09/2017. Managerial Problem. Solution Approach. Take-away Costs Costs: Introduction Managerial Problem Technology choice at home versus abroad: In western countries, firms use relatively capital-intensive technology. Will that same technology be cost minimizing

More information

Supply and demand are the two words that economists use most often.

Supply and demand are the two words that economists use most often. Chapter 13. The Costs of Production The Market Forces of Supply and Demand Supply and demand are the two words that economists use most often. Supply and demand are the forces that make market economies

More information

Total Costs. TC = TFC + TVC TFC = Fixed Costs. TVC = Variable Costs. Constant costs paid regardless of production

Total Costs. TC = TFC + TVC TFC = Fixed Costs. TVC = Variable Costs. Constant costs paid regardless of production AP Microeconomics Total Costs TC = TFC + TVC TFC = Fixed Costs Constant costs paid regardless of production TVC = Variable Costs Costs that vary as production is changed Cost TFC TVC TFC Output Profit

More information

START UP: STREET CLEANING AROUND THE WORLD

START UP: STREET CLEANING AROUND THE WORLD CHAPTER 8 Production and Cost START UP: STREET CLEANING AROUND THE WORLD It is dawn in Shanghai, China. Already thousands of Chinese are out cleaning the city s streets. They are using brooms. On the other

More information

Profit. Total Revenue The amount a firm receives for the sale of its output. Total Cost The market value of the inputs a firm uses in production.

Profit. Total Revenue The amount a firm receives for the sale of its output. Total Cost The market value of the inputs a firm uses in production. Profit Total Revenue The amount a firm receives for the sale of its output. Total Cost The market value of the inputs a firm uses in production. Profit is the firm s total revenue minus its total cost.

More information

CHAPTER-3 COST. (c) Average variable cost. (d) Opportunity costs. 1. Marginal cost is the cost:

CHAPTER-3 COST. (c) Average variable cost. (d) Opportunity costs. 1. Marginal cost is the cost: CHAPTER-3 COST (c) Average variable cost (d) Opportunity costs 1. Marginal cost is the cost: (a) Of the last unit production (b) Of the Marginal unit (c) Of the marginal efficient unit (d) Of the average

More information

Unit 5. Producer theory: revenues and costs

Unit 5. Producer theory: revenues and costs Unit 5. Producer theory: revenues and costs Learning objectives to understand the concept of the short-run production function, describing the relationship between the quantity of inputs and the quantity

More information

7 Costs. Lesson. of Production. Introduction

7 Costs. Lesson. of Production. Introduction Lesson 7 Costs of Production Introduction Our study now combines what we have learned about price from Lesson 5 with utility theory from Lesson 6 to allocate resources among cost factors. Consider that

More information

Firm Behavior and the Costs of Production

Firm Behavior and the Costs of Production Firm Behavior and the Costs of Production WHAT ARE COSTS? The Firm s Objective The economic goal of the firm is to maximize profits. Total Revenue, Total Cost, and Profit Total Revenue, Total Cost, and

More information

The Firm s Objective. A Firm s Total Revenue and Total Cost. The economic goal of the firm is to maximize profits. A Firm s Profit

The Firm s Objective. A Firm s Total Revenue and Total Cost. The economic goal of the firm is to maximize profits. A Firm s Profit The s of Production Chapter 13 Copyright 2001 by Harcourt, Inc. The s of Production The Law of Supply: Firms are willing to produce and sell a greater quantity of a good when the price of the good is high.

More information

Theory of Produc-on. Lecture #4 Microeconomics

Theory of Produc-on. Lecture #4 Microeconomics Theory of Produc-on Lecture #4 Microeconomics Topics 1. How firms produce goods and services. 2. Produc7on in the short run. 3. Costs or factors of produc7on. 4. Economies of scale and produc7on in the

More information

Chapter 23: Theory of the firm short run costs (1.5) [11 pages]

Chapter 23: Theory of the firm short run costs (1.5) [11 pages] 1/11 Chapter 23: Theory of the firm short run costs (1.5) [11 pages] HL extensions Short and long run costs Total cost picture Unit cost picture Linking total product to the unit cost picture Calculating

More information

The Theory and Estimation of Cost. Chapter 7. Managerial Economics: Economic Tools for Today s Decision Makers, 5/e By Paul Keat and Philip Young

The Theory and Estimation of Cost. Chapter 7. Managerial Economics: Economic Tools for Today s Decision Makers, 5/e By Paul Keat and Philip Young The Theory and Estimation of Cost Chapter 7 Managerial Economics: Economic Tools for Today s Decision Makers, 5/e By Paul Keat and Philip Young The Theory and Estimation of Cost The Importance of Cost

More information

Short Run Costs. The Costs of Production. Fixed Costs, Variable Costs, and Total Costs. Fixed Costs, Variable Costs, and Total Costs

Short Run Costs. The Costs of Production. Fixed Costs, Variable Costs, and Total Costs. Fixed Costs, Variable Costs, and Total Costs The Costs of Production Short Run Costs Part 2 There are many different types of costs. Invariably, firms believe costs are too high and try to lower them. Fixed Costs, Variable Costs, and Total Costs

More information

HOMEWORK ECON SFU

HOMEWORK ECON SFU HOMEWORK 1998-2 ECON 103 - SFU the law of diminishing returns have on short-run costs? Be specific. (e) âwhen... And when marginal product is diminishing, marginal cost is rising.â Illustrate and... ECON

More information

Ch. 8 Costs and the Supply of Goods. 1. they purchase productive resources from households and other firms

Ch. 8 Costs and the Supply of Goods. 1. they purchase productive resources from households and other firms Ch. 8 Costs and the Supply of Goods Organization of the business firm What do firms do? 1. they purchase productive resources from households and other firms 2. then they transform those resources into

More information

ECON 2100 Principles of Microeconomics (Summer 2016) The Production Process and Costs of Production

ECON 2100 Principles of Microeconomics (Summer 2016) The Production Process and Costs of Production ECON 21 Principles of Microeconomics (Summer 216) The Production Process and of Production Relevant readings from the textbook: Mankiw, Ch. 13 The of Production Suggested problems from the textbook: Chapter

More information

= AFC + AVC = (FC + VC)

= AFC + AVC = (FC + VC) Chapter 13-14: Marginal Product, Costs, Revenue, and Profit Production Function The relationship between the quantity of inputs (workers) and quantity of outputs Total product (TP) is the total amount

More information

Costs in the Short Run: NOTE: Costs depend upon output!! Fixed Costs (FC) costs which do not change when a business changes its quantity of output.

Costs in the Short Run: NOTE: Costs depend upon output!! Fixed Costs (FC) costs which do not change when a business changes its quantity of output. Costs in the Short Run: NOTE: Costs depend upon output!! Fixed Costs (FC) costs which do not change when a business changes its quantity of output. Variable Costs (VC) costs which do change when a business

More information

541: Economics for Public Administration Lecture 8 Short-Run Costs & Supply

541: Economics for Public Administration Lecture 8 Short-Run Costs & Supply I. Introduction 541: Economics for Public Administration Lecture 8 Short-Run s & Supply We have presented how a business finds the least cost way of providing a given level of public good or service. In

More information

Production and Cost. This Is What You Need to Know. Explain the difference between accounting and economic costs and how they affect the determination

Production and Cost. This Is What You Need to Know. Explain the difference between accounting and economic costs and how they affect the determination Chiang_3E_CT_Micro_CH07_Layout 1 3/20/14 2:29 PM Page 175 7 Production and Cost Production and Cost Are Behind Decisions About Supply Having looked in the last chapter at what lies behind demand curves

More information

Economics 203: Intermediate Microeconomics I Lab Exercise #4

Economics 203: Intermediate Microeconomics I Lab Exercise #4 February 29, 2016 Economics 203: Intermediate Microeconomics I Lab Exercise #4 Section 1: Discussion: As the electronics industry has grown more mature and new technologies have been developed, the costs

More information

Practice Questions- Chapter 6

Practice Questions- Chapter 6 Practice Questions- Chapter 6 Harvey quit his job where he earned $45,000 a year. He figures his entrepreneurial talent or foregone entrepreneurial income to be $5,000 a year. To start the business, he

More information

This is Production and Cost, chapter 8 from the book Microeconomics Principles (index.html) (v. 1.0).

This is Production and Cost, chapter 8 from the book Microeconomics Principles (index.html) (v. 1.0). This is Production and Cost, chapter 8 from the book Microeconomics Principles (index.html) (v. 1.0). This book is licensed under a Creative Commons by-nc-sa 3.0 (http://creativecommons.org/licenses/by-nc-sa/

More information

Lesson-22. Cost Analysis-I

Lesson-22. Cost Analysis-I Lesson-22 Cost Analysis-I Introduction to Cost We can look at the business firm from at least two points of view: productivity, inputs, and outputs or outputs and costs. In advanced microeconomics, these

More information

Using this information, we then write the output of a firm as

Using this information, we then write the output of a firm as Economists typically assume that firms or a firm s owners try to maximize their profit. et R be revenues of the firm, and C be the cost of production, then a firm s profit can be represented as follows,

More information

The Cost of Production

The Cost of Production C H A P T E R 7 The Cost of Production Prepared by: Fernando & Yvonn Quijano CHAPTER 7 OUTLINE 7.1 Measuring Cost: Which Costs Matter? 7.2 Cost in the Short Run 7.3 Cost in the Long Run 7.4 Long-Run versus

More information

CHAPTER 5 FIRM PRODUCTION, COST, AND REVENUE

CHAPTER 5 FIRM PRODUCTION, COST, AND REVENUE CHAPTER 5 FIRM PRODUCTION, COST, AND REVENUE CHAPTER OBJECTIVES You will find in this chapter models that will help you understand the relationship between production and costs and the relationship between

More information

ECONOMICS STANDARD XII (ISC) Chapter 8: Cost and Revenue Analysis

ECONOMICS STANDARD XII (ISC) Chapter 8: Cost and Revenue Analysis ECONOMICS STANDARD XII (ISC) Chapter 8: Cost and Revenue Analysis Q1) Define the following: i. Money cost Money cost refers to money expenses which the firm has to incur in purchasing or hiring factor

More information

3. Definition of constant returns to scale: the property whereby long-run average total cost stays the same as the quantity of output changes.

3. Definition of constant returns to scale: the property whereby long-run average total cost stays the same as the quantity of output changes. 250 Chapter 13/The s of Production 3. Definition of constant returns to scale: the property whereby long-run average total cost stays the same as the quantity of output changes. 4. FYI: Lessons from a

More information

not to be republished NCERT Chapter 6 Non-competitive Markets 6.1 SIMPLE MONOPOLY IN THE COMMODITY MARKET

not to be republished NCERT Chapter 6 Non-competitive Markets 6.1 SIMPLE MONOPOLY IN THE COMMODITY MARKET Chapter 6 We recall that perfect competition was theorised as a market structure where both consumers and firms were price takers. The behaviour of the firm in such circumstances was described in the Chapter

More information

b. The marginal opportunity cost of an executive s flight is the price the company could have earned from leasing the jet to someone else.

b. The marginal opportunity cost of an executive s flight is the price the company could have earned from leasing the jet to someone else. Chapter 6 Costs SOLUTIONS TO END-OF-CHAPTER QUESTIONS THE NATURE OF COSTS 1.1 The ships that return to Asia are half or completely empty; therefore, the cost of having more merchandise in them is almost

More information

CHAPTER 8: THE COSTS OF PRODUCTION

CHAPTER 8: THE COSTS OF PRODUCTION CHAPTER 8: THE COSTS OF PRODUCTION Introduction Now that we have examined consumer behavior in more detail, it is time to look at the decision making of the firm. Costs of production are important to determine

More information

Chief Reader Report on Student Responses:

Chief Reader Report on Student Responses: Chief Reader Report on Student Responses: 2018 AP Microeconomics Free-Response Questions Number of Students Scored 90,032 Number of Readers 91 Score Distribution Exam Score N %At 5 18,827 20.9 4 25,070

More information

Microeconomics (Cost, Ch 7)

Microeconomics (Cost, Ch 7) Microeconomics (Cost, Ch 7) Lectures 10-11-12 Feb 09/13/16, 2017 7.1 MEASURING COST: WHICH COSTS MATTER? Economic Cost versus Accounting Cost Opportunity Cost accounting cost Actual expenses plus depreciation

More information

Practice Exam 3: S201 Walker Fall 2009

Practice Exam 3: S201 Walker Fall 2009 Practice Exam 3: S201 Walker Fall 2009 I. Multiple Choice (3 points each) 1. Which of the following statements about the short-run is false? A. The marginal product of labor may increase or decrease. B.

More information

Contemporary Economics: An Applications Approach. Production. Production Function. Chapter 4: Production and the Costs of Production

Contemporary Economics: An Applications Approach. Production. Production Function. Chapter 4: Production and the Costs of Production Contemporary Economics: An Applications Approach By Robert J. Carbaugh 4th Edition Chapter 4: Production and the Costs of Production Copyright 2005 by South-Western, a division of Thomson Learning. All

More information

23 Perfect Competition

23 Perfect Competition 23 Perfect Competition Learning Objectives After you have studied this chapter, you should be able to 1. define price taker, total revenues, marginal revenue, short-run shutdown price, short-run breakeven

More information

BEHAVIOUR AND THE ORGANIZATION OF INDUSTRY

BEHAVIOUR AND THE ORGANIZATION OF INDUSTRY 9 FIRM BEHAVIOUR AND THE ORGANIZATION OF INDUSTRY LEARNING OBJECTIVES In this chapter you will: Examine what items are included in a firm s costs of production Analyze the link between a firm s production

More information

ECONOMICS ASSIGNMENT CLASS XII MICRO ECONOMICS UNIT I INTRODUCTION. 4. Is free medicine given to patients in Govt. Hospital a scarce commodity?

ECONOMICS ASSIGNMENT CLASS XII MICRO ECONOMICS UNIT I INTRODUCTION. 4. Is free medicine given to patients in Govt. Hospital a scarce commodity? ECONOMICS ASSIGNMENT CLASS XII MICRO ECONOMICS UNIT I INTRODUCTION 1. What is the Slope of PPC? What does it show? 2. When can PPC be a straight line? 3. Do all attainable combination of two goods that

More information

Practice Exam 3: S201 Walker Fall with answers to MC

Practice Exam 3: S201 Walker Fall with answers to MC Practice Exam 3: S201 Walker Fall 2007 - with answers to MC Print Your Name: I. Multiple Choice (3 points each) 1. If marginal utility is falling then A. total utility must be falling. B. marginal utility

More information

Managerial Economics Prof. Trupti Mishra S. J. M. School of Management Indian Institute of Technology, Bombay

Managerial Economics Prof. Trupti Mishra S. J. M. School of Management Indian Institute of Technology, Bombay Managerial Economics Prof. Trupti Mishra S. J. M. School of Management Indian Institute of Technology, Bombay Lecture - 2 Introduction to Managerial Economics (Contd ) So, welcome to the second session

More information

COST THEORY. I What costs matter? A Opportunity Costs

COST THEORY. I What costs matter? A Opportunity Costs COST THEORY Cost theory is related to production theory, they are often used together. However, here the question is how much to produce, as opposed to which inputs to use. That is, assume that we use

More information

TEST 3 J. Spraggon Student Number: November 21, 2003

TEST 3 J. Spraggon Student Number: November 21, 2003 Econ 1100 Name: TEST 3 J. Spraggon Student Number: November 21, 2003 This test consists of 9 pages, containing 42 multiple-choice questions. There will be 1 mark for each of the multiple choice questions.

More information

1. If the per unit cost of production falls, then... A.) the supply curve shifts right (or down)

1. If the per unit cost of production falls, then... A.) the supply curve shifts right (or down) 1. If the per unit cost of production falls, then... A.) the supply curve shifts right (or down) B.) there is a downward movement along the existing supply curve which does not shift C.) the supply curve

More information

ECONOMICS 110/111* Assignment #3 Suggested Solutions

ECONOMICS 110/111* Assignment #3 Suggested Solutions Due Dates and Notes: ECONOMICS 110/111* Assignment #3 Suggested Solutions 2011/2012 DUE: By Friday November 18, 2:00 PM. Completed assignments should be placed in the slot marked for your section in the

More information

2000 AP Microeconomics Exam Answers

2000 AP Microeconomics Exam Answers 2000 AP Microeconomics Exam Answers 1. B Scarcity is the main economic problem!!! 2. D If the wages of farm workers and movie theater employee increase, the supply of popcorn and movies will decrease (shift

More information

Pledge (sign) I did not copy another student s answers

Pledge (sign) I did not copy another student s answers Economics 4020 Dr. Rupp Test #1 Fri. Sept 23 rd, 2011 20 Multiple Choice questions (2.5 points each) Pledge (sign) I did not copy another student s answers 1. The profit maximization rule for a firm is

More information

Edexcel (A) Economics A-level

Edexcel (A) Economics A-level Edexcel (A) Economics A-level Theme 3: Business Behaviour & the Labour Market 3.3 Revenue Costs and Profits 3.3.2 Costs Notes Formulae to calculate types of costs Total cost: This is how much it costs

More information

1 of 14 5/1/2014 4:56 PM

1 of 14 5/1/2014 4:56 PM 1 of 14 5/1/2014 4:56 PM Any point on the budget constraint Gives the consumer the highest level of utility. Represent a combination of two goods that are affordable. Represents combinations of two goods

More information

ECONOMICS CHAPTER 8: COST AND REVENUE ANALYSIS Class: XII(ISC) Q1) Define the following:

ECONOMICS CHAPTER 8: COST AND REVENUE ANALYSIS Class: XII(ISC) Q1) Define the following: Q1) Define the following: ECONOMICS CHAPTER 8: COST AND REVENUE ANALYSIS Class: XII(ISC) 2017-2018 i. Money cost Money cost refers to money expenses which the firm has to incur in purchasing or hiring

More information

The Structure of Costs in the

The Structure of Costs in the The Structure of s in the Short Run The Structure of s in the Short Run By: OpenStaxCollege The cost of producing a firm s output depends on how much labor and physical capital the firm uses. A list of

More information

CONTENT TOPIC 3: SUPPLY, PRODUCTION AND COST. The Supply Process. The Role of the Firm 10/10/2016

CONTENT TOPIC 3: SUPPLY, PRODUCTION AND COST. The Supply Process. The Role of the Firm 10/10/2016 CONTENT TOPIC 3: SUPPLY, PRODUCTION AND COST - The factors of production - Combining factors of production: The law of returns - Costs of production: Short & Long Run - Deciding whether to produce in the

More information

Eco402 - Microeconomics Glossary By

Eco402 - Microeconomics Glossary By Eco402 - Microeconomics Glossary By Break-even point : the point at which price equals the minimum of average total cost. Externalities : the spillover effects of production or consumption for which no

More information

Topic 3. Demand and Supply

Topic 3. Demand and Supply Econ 103 Topic 3 page 1 Topic 3 Demand and Supply Text reference: Chapter 3 and 4. Assumptions of the competitive model. Demand: -Determinants of demand -Demand curves -Consumer surplus -Divisibility -

More information

ECON 101 (GATEMAN) MIDTERM EXAM REVIEW SESSION BY COLIS CHENG

ECON 101 (GATEMAN) MIDTERM EXAM REVIEW SESSION BY COLIS CHENG ECON 101 (GATEMAN) MIDTERM EXAM REVIEW SESSION BY COLIS CHENG TABLE OF CONTENT I. Exam Tips and Strategies II. Chapter 6 Crash Course III. Chapter 7 Crash Course IV. Chapter 8 Crash Course V. Critical

More information

CASE FAIR OSTER PEARSON 2012 Pearson Education, Inc. Publishing as Prentice Hall

CASE FAIR OSTER PEARSON 2012 Pearson Education, Inc. Publishing as Prentice Hall PART II The Market System: Choices Made by Households and Firms PRINCIPLES OF MICROECONOMICS E L E V E N T H E D I T I O N CASE FAIR OSTER PEARSON 2012 Pearson Education, Inc. Publishing as Prentice Hall

More information

ECONOMICS 103. Topic 3: Supply, Demand & Equilibrium

ECONOMICS 103. Topic 3: Supply, Demand & Equilibrium ECONOMICS 103 Topic 3: Supply, Demand & Equilibrium Assumptions of the competitive market model: all agents are price takers, homogeneous products. Demand & supply: determinants of demand & supply, demand

More information

Chapter 1- Introduction

Chapter 1- Introduction Chapter 1- Introduction A SIMPLE ECONOMY Central PROBLEMS OF AN ECONOMY: scarcity of resources problem of choice Every society has to decide on how to use its scarce resources. Production, exchange and

More information

Understanding Production Costs. Principles of Microeconomics Module 4

Understanding Production Costs. Principles of Microeconomics Module 4 Understanding Production Costs Principles of Microeconomics Module 4 Firm Decisions: Short Run and Long Run A firm s decisions are grouped as: Short-run decisions time horizon over which at least one of

More information

Economics MCQ (1-50) GAT Subject Management Sciences.

Economics MCQ (1-50) GAT Subject Management Sciences. Economics MCQ (1-50) GAT Subject Management Sciences www.accountancyknowledge.com 51. If a 5% increase in price causes no change in total revenue, this means? (a) Demand is price inelastic (b) Demand is

More information

Review Notes for Chapter Optimal decision making by anyone Engage in an activity up to the point where the marginal benefit= marginal cost

Review Notes for Chapter Optimal decision making by anyone Engage in an activity up to the point where the marginal benefit= marginal cost Review Notes for Chapter 5 1. Optimal decision making by anyone Engage in an activity up to the point where the marginal benefit= marginal cost Sunk costs are costs which must be borne regardless of future

More information

AP Krugman Economics Section 10 Problem Solutions. AP Krugman Microeconomics Section 4 Problem Solutions

AP Krugman Economics Section 10 Problem Solutions. AP Krugman Microeconomics Section 4 Problem Solutions AP Krugman Economics Section 10 Problem Solutions AP Krugman Microeconomics Section 4 Problem Solutions 1. a. Hiro s accounting profit is: $100,000 (total revenue) -$55,000 (travel and other expenses)

More information

THE COSTS OF PRODUCTION PART II

THE COSTS OF PRODUCTION PART II THE COSTS OF PRODUCTION PART II It is one of the greatest economic errors to put any limitation on production... We have not the power to produce more than there is the potential to consume. - Louis D.

More information

Homework 2: Managerial Economics Due Date: September 13, 2018

Homework 2: Managerial Economics Due Date: September 13, 2018 Homework 2: Managerial Economics Due Date: September 13, 2018 uestion 1 a. For = 8 we can compute the total fixed costs. We have: TC = TFC +TVC, (1) TC = TFC + AVC, (2) 1070 = TFC +8 15, TFC = 350. (3)

More information

Chapter Summary and Learning Objectives

Chapter Summary and Learning Objectives CHAPTER 11 Firms in Perfectly Competitive Markets Chapter Summary and Learning Objectives 11.1 Perfectly Competitive Markets (pages 369 371) Explain what a perfectly competitive market is and why a perfect

More information

Cost Theory and Estimation EC611--Managerial Economics

Cost Theory and Estimation EC611--Managerial Economics Cost Theory and Estimation EC611--Managerial Economics Dr. Savvas C Savvides, European University Cyprus The Nature of Costs Accounting cost actual payments made by a firm in a period Opportunity cost

More information