CDAE 254 - Class 20 Nov. 1
Last class:
Problem set 5
6. Costs
Quiz 5
Today:
Result of Quiz 5
6. Costs
Next class:
7. Profit maximization and supply
Quiz 6 (Chapter 6)
Important date:
Problem set 5: due today
Result of Quiz 5
N = 55
Range = 3 – 10
Average = 7.8
6. Costs
6.1.
6.2.
6.3.
6.4.
6.5.
6.6.
6.7.
6.8.
Basic concepts of costs
Cost minimizing input choice
Cost curves
Short-run and long-run costs
Per unit short-run cost curves
Shifts in cost curves
An example
Applications
6.3. Cost curves
6.3.1. Possible shapes of the total cost curve
(function): relation between TC and q
(Fig. 6.3)
(1) Constant returns to scale
(2) Decreasing returns to scale
(3) Increasing returns to scale
(4) Optimal scale: increasing returns to
scale followed by decreasing
returns to scale
A practice question:
If TC=50 for Q=20 and TC=90 for Q=40, what is the returns to
scale of this production?
6.3. Cost curves
6.3.2. Average cost (AC) & marginal cost (MC)
(1) What is the AC and what is the MC?
AC = TC/q
MC = ΔTC/Δq
(2) AC & MC curves (functions) (Fig. 6.4)
(a)
(b)
(c)
(d)
Constant returns to scale
Decreasing returns to scale
Increasing returns to scale
Optimal scale
A practice question:
If MC<AC, what is the returns to scale?
6.3. Cost curves
6.3.2. Average cost and marginal cost
(3) Optimal scale: Relationship between
AC and MC
(4) Optimal scale: Lowest AC input
choice
When MC < AC, AC is decreasing
When MC > AC, AC is increasing
When MC = AC, AC is at the
minimum level.
6.4. Short run and long run costs
6.4.1. Very short run, short run & long run
Very short run: K and L are fixed  Q is
also fixed
Short run: K is fixed and L change  Q can
change
Long run: both K and L can change  Q can
change
6.4.2. Input flexibility in the short-run and
long run (Fig. 6.5)
Short run: K is fixed and L can change
Long run: both K and L can change
6.4. Short run and long run costs
6.4.3. Short-run total costs:
STC = vK* + wL = SFC + SVC
6.4.4. Short-run fixed, variable & total cost
curves
Note that the concept “returns to scale” does
not apply in the short run.
6.5. Per-unit short run cost curves
6.5.1. Short-run average cost: SAC = STC / q
6.5.2. Short-run marginal cost
SMC = ΔSTC/Δq
6.5.3. SAC and SMC curves
6.5.4. Long-run average cost & marginal cost
6.5.5. Relationship between short-run and
long-run cost curves
6.5.6. An example: choosing an ink-jet printer
or laser printer
Ink-jet: STC = 80 + 0.07 q
Laser: STC = 200 + 0.04 q
6.6. Shifts in cost curves
6.6.1. Change in input prices (w and v)
(1) w & v change in the same
proportion
-- TC, AC and MC will change
-- Expansion path will not change
(2) w & v change in difference
proportions
-- TC, AC and MC will change
-- Expansion path will change
6.6. Shifts in cost curves
6.6.2. Technology change
-- TC, AC and MC will change
-- Expansion path?
6.7. An example (continued from chapter 5)
Production function q  10 KL
Total cost TC = vK + wL= 5K + 5L
Isoquant of q = 40
Total cost of producing 40 units of q
Cost-minimizing input choice for q=40
L* = 4 and K* = 4, TC = 40
-- Long-run expansion path & costs
-- Short-run total cost (STC), short-run
average cost (SAC) and short-run marginal
cost (SMC)
------
6.7. An example (continued from chapter 5)
-- Comparison of short-run & long-run costs
6.8. Applications