MicroEconomics theory and application 12th by browning an zupan chapter 08

Prepared by Dr Della Lee Sue, Marist College MICROECONOMICS: Theory & Applications Chapter 8: The Cost of Production By Edgar K Browning & Mark A Zupan John Wiley & Sons, Inc 12th Edition, Copyright 2015 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives       Delineate the nature of a firm’s cost—explicit as well as implicit Outline how cost is likely to vary with output in the short run and various measures of shortrun cost Detail the typical shapes of a firm’s short-run cost curves See how a firm will choose to combine inputs in its production process in the long run when all inputs are variable Show how input price changes affect a firm’s cost curves Differentiate between a firm’s long-run and short-run cost curves (continued) Copyright © 2015 John Wiley & Sons, Inc All rights reserved Learning Objectives       (continued) Explain the impact of learning by doing on production cost Understand how the minimum efficient scale of production is related to market structure Describe how cost curves can be applied to the problem of controlling pollution Cover economies of scope—is it cheaper for one firm to produce products jointly than it is for separate firms to produce the same products independently? Overview how cost functions can be empirically estimated through surveys and regression analysis Explain the mathematics behind production costs Copyright © 2015 John Wiley & Sons, Inc All rights reserved Delineate the nature of a firm’s cost—explicit as well as implicit 8.1 THE NATURE OF COST Copyright © 2015 John Wiley & Sons, Inc All rights reserved The Nature of Cost  Recall:  Explicit costs – arise from transactions in which the firm purchases inputs or the services of inputs from other parties  Implicit costs – costs associated with the use of the firm’s own resources and reflect the fact that these resources could be employed elsewhere  Opportunity cost reflects both explicit and implicit costs Copyright © 2015 John Wiley & Sons, Inc All rights reserved Outline how cost is likely to vary with output in the short run and various measures of shortrun cost 8.2 SHORT-RUN COST OF PRODUCTION Copyright © 2015 John Wiley & Sons, Inc All rights reserved Measures of Short-Run Cost   Total fixed cost (TFC) – the cost incurred by the firm that does not depend on how much output it produces Total variable cost (TVC) – the cost incurred by the firm that depends on how much output it produces Copyright © 2015 John Wiley & Sons, Inc All rights reserved Fixed versus Sunk Costs  Fixed cost – input cost that is invariant to the output level selected by the firm; relevant cost even when output is zero  Sunk cost – cannot be recouped through the sale of inputs Copyright © 2015 John Wiley & Sons, Inc All rights reserved Table 8.1 Copyright © 2015 John Wiley & Sons, Inc All rights reserved Five Other Measures of Short-Run Cost  Total cost (TC) – the sum of total fixed and total variable cost at each output level  Marginal cost (MC) – the change in total cost that results from a oneunit change in output  Average fixed cost (AFC) – total fixed cost divided by the amount of output  Average variable cost (AVC) – total variable cost divided by the amount of output  Average total cost (ATC) – total cost divided by the output Copyright © 2015 John Wiley & Sons, Inc All rights reserved 10 Describe how cost curves can be applied to the problem of controlling pollution 8.9 USING COST CURVES: CONTROLLING POLLUTION Copyright © 2015 John Wiley & Sons, Inc All rights reserved 43 Using Cost Curves: Controlling Pollution  Question: Can the government’s program to reduce pollution be accomplished at the lowest possible cost?  If marginal costs of firms differ, the total cost of pollution abatement can be reduced:  Increase abatement when MC is less  Decrease abatement where MC is greater  Result: firms should operate where their MC are equal Copyright © 2015 John Wiley & Sons, Inc All rights reserved 44 Figure 8.10 – Cost of Pollution Abatement Copyright © 2015 John Wiley & Sons, Inc All rights reserved 45 Cover economies of scope—is it cheaper for one firm to produce products jointly than it is for separate firms to produce the same products independently? 8.10 ECONOMIES OF SCOPE Copyright © 2015 John Wiley & Sons, Inc All rights reserved 46 Economies of Scope and Diseconomies of Scope  Economies of scope – a case where it is cheaper for one firm to produce products jointly than it is for separate firms to produce the same products independently  Diseconomies of scope – a case where it is cheaper for separate products to be produced independently than for one firm to produce the same products jointly Copyright © 2015 John Wiley & Sons, Inc All rights reserved 47 Overview how cost functions can be empirically estimated through surveys and regression analysis 8.11 ESTIMATING COST FUNCTIONS Copyright © 2015 John Wiley & Sons, Inc All rights reserved 48 Estimating Cost Functions Techniques:  Surveys  New entrant/survivor technique – method for determining the minimum efficient scale of production in an industry based on investigating the plant sizes either being built or used by firms in the industry  Econometric specification Copyright © 2015 John Wiley & Sons, Inc All rights reserved 49 Figure 8.11 - Different Possible Cost Functions Copyright © 2015 John Wiley & Sons, Inc All rights reserved 50 Explain the mathematics behind production costs 8.12 THE MATHEMATICS BEHIND PRODUCTION COST* *Denotes digital-only content Copyright © 2015 John Wiley & Sons, Inc All rights reserved 51 The Marginal-Average Cost Relationship   Analogous to the derivation of the relationship between marginal and average product curves Relationship holds for both the long-run and short-run cost curves Copyright © 2015 John Wiley & Sons, Inc All rights reserved 52 Cost Minimization The firm’s input choices can be viewed as either:  Maximizing output for a given level of total cost, or  Minimizing the cost necessary to produce a given output (continued) Copyright © 2015 John Wiley & Sons, Inc All rights reserved 53 Cost Minimization Copyright © 2015 John Wiley & Sons, Inc All rights reserved 54 Cost Minimization Copyright © 2015 John Wiley & Sons, Inc All rights reserved 55 Minimizing the Cost of Pollution Abatement  For pollution to be reduced at the lowest possible cost, each firm must be operating where the marginal cost of pollution abatement is the same  Lagrangian technique  Constrained minimization Copyright © 2015 John Wiley & Sons, Inc All rights reserved 56 Minimizing the Cost of Pollution Abatement (continued) Copyright © 2015 John Wiley & Sons, Inc All rights reserved 57 ... the LongRun Expansion Path Copyright © 2015 John Wiley & Sons, Inc All rights reserved 21 Least Costly Input Combination  A point of tangency between an isocost line and an isoquant show the least... how input price changes affect a firm’s cost curves 8.5 INPUT PRICE CHANGES AND COST CURVES Copyright © 2015 John Wiley & Sons, Inc All rights reserved 27 Input Price Changes and Cost Curves The... ever-larger rates of output The ATC curve is the sum of AFC and AVC It measures the average unit cost of all inputs, both fixed and variable, and must also be Ushaped Copyright © 2015 John Wiley &