Costs
Costs in economics
Different types of costs
Accounting cost: direct costs of operating a
business
Opportunity cost:
Value of what a producer gives up by using
an input
Economic cost: sum of a producer’s
accounting and opportunity costs
Costs in economics
Economic profit = total revenue - economic
cost
Short run
Fixed costs (FC): costs that do not vary
with output.
They are associated with fixed inputs.
Variable costs (VC): costs that do vary with
output.
Sunk Costs
Sunk costs cannot be recouped and
therefore should not be considered if a firm
is deciding whether or not to close or
continue operation.
Sunk costs are always irrelevant.
Short run
Total Costs (TC) in the short run
TC = FC + VC
Short run
FC curve: always horizontal
VC curve: Changes with the amount of
output
Its slope is always positive
£
Its shape depends on the productivity of the
variable input
Short run
TC
£
VC
FC
Q
Short run
Short run average (total) cost
SRTC VC FC
SRAC =
=
+
= AVC + AFC
Q
Q
Q
Average Fixed Cost: As Q rises AFC falls
Short run
Average Variable Cost:
AVC = VC/ Q
Costs
Short run
Output (Q)
Short run
Short run Marginal Cost = change in TC
brought about by a change in one unit of
output
ΔTC ΔVC ΔFC ΔVC
SRMC =
=
+
=
= SRMC
ΔQ
ΔQ
ΔQ
ΔQ
dTC
MC =
dQ
Short run
Short run Marginal Cost = change in TC
brought about by a change in one unit of
output.
MC = dTC/dQ
the additional cost of an additional unit of
output.
Eg:
TC = 30 + 3Q +5Q2
Then, MC = dTC/dQ = 3 + 10Q.
Costs
Short run
Q
Short run all costs
Costs
£
MC
AVC
AC
AFC
Q
Short run costs
Costs
MC
AC
AVC
Q
Short run
The Short run production function, Q= f(L;
K0), determines the shape of a firm’s cost
curves.
In general Short run costs are not minimal
costs for producing the various output
levels
Short run
In the short run he firm does not have the
flexibility of input choice to vary its output
in the short run, so the firm may use nonoptimal input combinations
Long run
In the long-run
Complete flexibility
All factors of production can be varied: Q =
f(K,L)
Firms can minimize the cost of production
Long run
Cost minimization refers to the firm’s goal
of producing a specific quantity of output
at minimum cost
The firm will minimize costs subject to a
specific amount of output that must be
produced
Long run vs Short run
Costs
Marginal costs
MC (LR)
SRAC1
SRAC2
SRAC3
AC (LR)
Q
Minimum efficient scale
(MES)