Costs
Perloff Chapter 7
Economic cost
• business (accounting) costs: only explicit costs
(out of pocket)
• economic costs: explicit cost + implicit cost =
opportunity cost
• opportunity cost
– value of best alternative use of the resource
– classic example: "There's no such thing as a free lunch"
Short-run costs
Source: Perloff
Cost, $
400
Short-run cost
curves
C
VC
27
A
216
1
20
1
B
120
48
0
F
2
4
6
8
10
Quantity,q, Units per day
60
MC
a
28
27
AVC
b
20
AC
8
AFC
0
Source: Perloff
2
4
6
8
10
Quantity, q, Units per day
Total product curve and VC
Quantity, q,
Units per day
Total product of labor,
Variable cost
13
10
6
5
1
0
Source: Perloff
5
25
20 24
100 120
46
230
77
385
L, Hours of labor per day
VC = wL, Variable cost, $
Shape of MC and AC curve
VC
MC 
q
MC  w
MC 
L
q
w
MPL
VC
AC 
q
wL
q
w
AC 
APL
AC 
The long-run: input choice
C  wL  rK
Source: Perloff
C w
K  L
r r
Isocost Lines
K, Units of
capital per year
C w
K  L
r r
$150
15 = ———
$10
$100 e
10 = ———
$10
d
$50
5=—
——
$10
c
b
$50 isocost
$100 isocost
$150 isocost
a
Source: Perloff
$50 =
—
—
— 10
$5
$100
$150 =
——— = 20
—
—— 30
$5
$5
, Units of labor per year
Cost minimisation
K, Units of
capital per year
Lowest isocost rule
Tangency rule
q = 100 isoquant
3,000-kr
isocost
y
303
2,000-kr
isocost
1,000-kr
isocost
x
100
z
28
0
Source: Perloff
24
50
116
L , Units of labor per year
Three (equivalent) rules for cost
minimisation
1. Lowest Isocost
2. Tangency
w MPL
MRTS   
r MPK
3. Last dollar rule (equimarginal returns)
MPL MPK

w
r
Cobb-Douglas example
q  1.52 L0.6 K 0.4
q
MPL  0.6
L
q
MPK  0.4
K
At X:
100
 1 .2
50
MPL 1.2

 0.05
w
24
K, Units of
capital per year
x
100
MPL  0.6
100
 0.4
100
MPK 0.4

 0.05
w
8
MPK  0.4
Source: Perloff
y
303
z
28
0
24
50
116
L, Units of labor per year
At Y:
100
 2 .5
24
MPL 2.5

 0 .1
w
24
MPL  0.6
100
 0.13
303
MPK 0.13

 0.016
w
8
MPK  0.4
Factor price changes
K, Units of
capital per year
q = 100 isoquant
Original
isocost,
2,000 kr
New isocost,
1,032 kr
100
x
v
52
0
Source: Perloff
50
77
L, Workers per year
Expansion path
K, Units of
capital per year
4,000-kr isocost
3,000-kr
isocost
Expansion path
2,000-kr
isocost
z
200
y
150
x
100
0
Source: Perloff
200 isoquant
50
75
100
150 isoquant
100 isoquant
L, Workers per year
Long run total cost curve
Long-run cost curve
C, Cost, kroner
4,000
Z
3,000
2,000
0
Source: Perloff
Y
X
100
150
200
q, Units per year
Returns to scale and LAC
K, Units of
capital per year
d
8
q= 8
c  d: Decreasing returns to scale
c
4
q= 6
b
2
b  c : Constant returns to scale
a
1
Source: Perloff
0
q=3
q =1
1
2
4
a  b: Increasing returns to scale
8
L, Work hours per year
Returns to scale and LAC (cont)
Source: Perloff
K, Capital
per year
Long and short run expansion
4,616 kr
Long-run expansion path
4,000 kr
2,000 kr
z
200
y
x
100
0
Source: Perloff
50
100
159
Short-run
expansion path
200 isoquant
100 isoquant
L, Workers per year
Relationship between LAC and
SAC
Average cost, $
SRAC
SRAC 1
b
12
10
a
SRAC 3
3
LRAC
SRAC 2
d
c
e
0
Source: Perloff
q1
q2
q, Output per day
Learning by doing
Average cost
Improvements in
productivity which
result from
knowledge and
experience
Economies of scale
A
B
Learning by doing
C
b
AC 1
c
AC 2
AC 3
q1
Source: Perloff
q2
q3
q, Output per period