EC4004 Lecture 10: Costs

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EC4004 Lecture 10: Costs

  1. 1. EC4004 Lecture 10: Costs Dr. S. Kinsella
  2. 2. Dates: October 17th -24th Best of 2 attempts 10% of Final Grade
  3. 3. Yesterday
  4. 4. Production Function
  5. 5. Marginal Products
  6. 6. Diminishing Marginal Productivity
  7. 7. Isoquants
  8. 8. Marginal Rate of Technical substitution
  9. 9. Today: Returns to Scale; Costs
  10. 10. Constant Returns to Scale
  11. 11. A Capital per week 4 q = 40 3 q = 30 2 q = 20 1 q = 10 0 1 2 3 4 Labor per week (a) Constant Returns to Scale
  12. 12. Decreasing Returns to Scale
  13. 13. A Capital A Capital per week per week 4 4 q = 40 3 3 q = 30 q = 30 2 2 q = 20 q = 20 1 1 q = 10 q = 10 Labor Labor 0 1 2 3 4 per week 0 1 2 3 4 per week (a) Constant Returns to Scale (b) Decreasing Returns to Scale
  14. 14. Increasing Returns to Scale
  15. 15. Capital per week A K2 q2 K1 q1 K0 q0 Labor 0 L0 L1 L2 per week
  16. 16. Technical Change Capital per week K1 K0 A q0 q’0 Labor 0 L1 L0 per week
  17. 17. Opportunity cost: cost of a good as measured by the alternative uses foregone by producing good or service. Accounting cost: concept that goods or services cost what was paid for them. Economic cost: amount required to keep a resource in its present use; the amount that it would be worth in its next best alternative use.
  18. 18. Labour Costs Wage, w
  19. 19. The cost of capital services (machine- hours) is the rental rate (v) which is the cost of hiring one machine for one hour.
  20. 20. Economic profit is revenue minus all costs including these entrepreneurial costs.
  21. 21. Total costs = TC = wL + vK. (8.1) Assuming the firm produces only one output, total revenue equals the price of the product (P) times its total output [q = f(K,L) where f(K,L) is the firm’s production function].
  22. 22. Economic profits (π): Difference between a firm’s total revenues and its total economic costs.
  23. 23. Minimizing the Costs of Producing q1 Capital per week TC1 TC2 TC3 K* q1 Labor 0 L* per week
  24. 24. Cost minimization requires that the marginal rate of technical substitution (RTS) of L for K equals the ratio of the inputs’ costs, w/v:
  25. 25. The firm’s expansion path is the set of cost-minimizing input combinations a firm will choose to produce various levels of output (when the prices of inputs are held constant).
  26. 26. Firm’s Expansion Path Capital per week TC1 TC3 TC2 Expansion path q3 K1 q2 q1 Labor 0 L1 per week
  27. 27. Cost Curves
  28. 28. Possible Shapes of the Total Cost Curve Total TC Total TC cost cost Quantity Quantity 0 0 per week per week (a) Constant Returns to Scale (b) Decreasing Returns to Scale TC Total Total cost TC cost Quantity 0 Quantity 0 per week per week (c) Increasing Returns to Scale (d) Optimal Scale
  29. 29. Average Costs Average cost is total cost divided by output; a common measure of cost per unit. If the total cost of producing 25 units is €100, the average cost would be: AC = €100/25 = €4
  30. 30. Marginal Cost The additional cost of producing one more unit of output is marginal cost. If the cost of producing 24 units is €98 and the cost of producing 25 units is €100, the marginal cost of the 25th unit is €2.
  31. 31. Average and Marginal Cost Curves AC, MC AC, MC MC AC AC, MC Quantity Quantity 0 0 per week per week (a) Constant Returns to Scale (b) Decreasing Returns to Scale AC, MC AC AC, MC MC AC MC Quantity Quantity 0 q* per week 0 per week (c) Increasing Returns to Scale (d) Optimal Scale
  32. 32. Shifts in Cost Curves Any change in economic conditions that affects the expansion path will also affect the shape and position of the firm’s cost curves. Three sources of such change are: change in input prices technological innovations, and economies of scope.
  33. 33. Next Time Production & Supply Chapter 9, Do Ex. 81, 8.3, 8.7
  34. 34. Survey
  35. 35. EC4004 Lecture 10: Costs Dr. S. Kinsella

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