Econ 100
Lecture 4.1
Costs of Production
Leftovers from Ch. 4
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Opportunity Costs (OC)
Supply Curves and OC
Total and Marginal Value
Costs: Fixed and Variable Costs
– Which Affect Economic Decisions?
Opportunity Costs
• Opportunity cost or economic opportunity
loss is the value of the next best alternative
foregone as the result of making a decision
– “things have no costs at all, only actions do
– “only costs that matter are marginal costs”
– “all opportunity costs are marginal costs and viceversa”
– Sunk costs are irrelevant to decision of what to do
next
Questions to Ponder
• Why does graduate school enrollment
increase during recessions? I.e., why are
more people willing to return to school
during recessions?
• What are the costs of an all volunteer
military? The costs for a military staffed by
a draft?
Opportunity Costs and
Resource Prices
• “Costs you pay for a resource, e.g. land, are
determined by the alternative opportunities that
people perceive for its use”
– How does the price of a lot in Seattle reflect its
“alternative” opportunities (or opportunity costs)?
– More generally, how does the price of any resource
used in production reflect its opportunity cost, i.e.,
“opportunities that people perceive for its use”
• E.g., corn as input for either food or ethanol
Supply Curves and
Opportunity Costs
• “Supply curves are marginal opportunity
cost curves of making various quantities of
a good available”
– How does the supply curve reflect opportunity
costs?
How Do Economist
Classify Costs?
• Are we talking about the short-run or the
long-run?
– Short-run: a period of time that is short
enough that at least 1 input (factor of
production) is fixed and can’t be adjusted to
changes in demand/output
• Inputs: Capital (K), Labor (L), Energy (E) and
(raw) Materials (M)
• E.g., usually capital is considered fix, too costly to
adjust immediately
How Do Economist
Classify Costs?
• Long-run
– Period of time long enough that ALL inputs
can be adjusted/varied
Fixed versus Variable Costs
• In the short-run:
– Since some inputs are fixed => some costs
are fixed (can’t be changed)
– And some inputs are changeable/variable
– Thus
• Total Costs(Qs) = Fixed Costs + Variable
Costs(Qs)
• In the long-run
• Total Costs(Qs) = Variable Costs(Qs)
Total and Variable Costs
on Average
• Short-run
– ATC(Qs) = TC(Qs)/Qs = 1/Qs [FC + VC(Qs)]
– ATC = AFC + AVC
– In the short-run only variable costs matter
• Will produce if you can cover VC
– Even if you can’t cover FC
• Long-run
– ATC(Qs) = AVC(Qs)]
• In the long-run all costs matter
• But all costs are variable costs
Sunk Costs and
Economic Decisions
– “Sunk costs are irrelevant to decision of what
to do next”
• Sunk costs  Fixed Costs
• Are fixed costs irrelevant to a firm’s business
decisions?
– Costs (in the short-run) are composed of two
elements
• Fixed Costs – don’t vary with the amount
supplied/produced (e.g., building rental)
• Variable Costs – do vary (e.g., labor, fuel, other
inputs into production)
Fixed Costs and Decisions
• If a firm can’t cover it’s fixed costs, but can
cover it’s variable costs – will it produce
any output?
– Short-run versus long-run
• Short-run: only variable (marginal costs) are
relevant
– If P >= MC then firm supplies up to Q* where P = MC(Q*)
• Long-run: when lease is up, rental becomes a
variable costs and firm will remain in business if
and only if Total Revenues >= Total Costs