2. Cost in the Short Run

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3 2. Cost in the Short Run Q TFC TVC TC MC AFC AVC ATC Fig 7.1 Cost Curves for a firm Total cost t Average cost TC TVC TFC MC Q ATC AVC Q TP=Q TVC w L MC= = Q Q w MC= MP L L Diminishing Marginal Returns Increasing Marginal Cost

4 3. Cost in the Long Run Isocost line Graph showing all possible combinations of labor and capital that can be purchased for a given total cost. Total cost in the long run = Total variable cost C = wl + rk The cost minimizing input choice K = C/r [w/r]l How many K and L will be used to minimize the total cost intercept slope Fig 7.3 Producing a Given Output at Minimum Cost K Question? K2 B What is the condition at point A? Let K/L is capital-labor ratio used in a production. In developed countries, labor is more expensive than capital. Therefore, we observed that K/L in those countries is high (capital-intensive). Use the cost minimizing input choice to explain this. K1 A K3 E q1 L2 L1 L3 L

5 Cost Minimization with varying output levels 4. Long Run Versus Short Run Cost Curve Expansion path Curve passing through points of tangency between a firm s isocost lines and its isoquants. Fig 7.7 The Inflexibility of Short-Run Production N M Fig 7.9 Relationship between SR and LR cost Economies and Diseconomies of Scale 1. Economies of scale (decreasing AC) Situation in which output can be doubled for less than a doubling of cost. 2. Diseconomies of scale (increasing AC) Situation in which a doubling of output requires more than a doubling of cost. Measuring Economies of Scale Ec = percentage change in C = C/C = MC percentage change in q q/q AC Ec > 1 diseconomies of scale (MC>AC) Ec < 1 economies of scale (MC<AC) Ec = 1 neither (MC=AC)

6 5. Production With Two Outputs-Economies of Scope Fig 7.10 Production Transformation Curve Curve showing the various combinations of two different outputs (products) that can be produced with a given set of inputs. Economies and Diseconomies of Scope 1. Economies of scope Situation in which joint output of a single firm is greater than output that could be achieved by two different firms when each produces a single product. 2. Diseconomies of scope Situation in which joint output of a single firm is less than could be achieved by separate firms when each produces a single product. Measuring Economies of Scale Sc = C(x)+C(y)-C(x,y) C(x,y) Sc > o Economies of scope Sc < 0 Diseconomies of scope I. "Even though I hate my Economics classes, I can't quit because I've spent so much money on tuition." II. "To break into the market for soap our firm needs to spend $10M on creating an image that is unique to our new product. When deciding whether to develop the new soap, we need to take this marketing cost into account." a) I only b) Neither I nor II c) II only d) Both I and II

7 a) 200 b) 5 + (200/Q) c) 5Q d) 5 Refer to Scenario 1. The total cost to produce 100 cookies is a) $0.25 b) $ c) $25.00 d) $0.10 Refer to Scenario 1. The total cost to produce 50 cookies is Refer to Scenario 1. For 100 cookies, the average total cost is a) $60 b) $20 c) $25 d) $50 a) rising. b) neither rising nor falling. c) falling. d) less than average fixed cost.

8 a) the income-consumption curve. b) the price-consumption curve. c) the long-run total cost curve. d) the expansion path. a) the slopes of the isoquant and isocost curves are equal. b) the marginal rate of technical substitution equals the ratio of input prices. c) costs are minimized for the production of a given output. d) all of the above a) could reduce the cost of producing its current output level by employing more capital and less labor. b) could increase its output at no extra cost by employing more capital and less labor. c) could reduce the cost of producing its current output level by employing more labor and less capital. d) is producing its current output level at the minimum cost. a) a horizontal line. b) a vertical line. c) equal to the 45-degree line from the origin. d) not defined.

9 a) opportunity costs are taken into account in the short run. b) diminishing returns apply in the short run. c) all inputs are variable in the long run. Then there are at least as many possibilities for substitution between factors of production in the long run as in the short run. d) returns to scale only exist in the long run. a) bowed inward (convex). b) bowed outward (concave). c) a straight line. d) a rectangle. a) fall to a minimum and then rise. b) increase. c) remain constant. d) decline.