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CHAPTER SEVEN- THE COST OF PRODUCTION - Coggle Diagram
CHAPTER SEVEN- THE COST OF PRODUCTION
Measuring cost
Economic cost
cost for using economic resources
future perspective
Economic cost = Opportunity cost
opportunity cost
-cost associated with opportunities forgone
accounting cost
actual expenses + depreciation for capital equipment
retrospective
sunk cost
money gone cant be recovered
should not influence firms decisions
prospective sunk cost is an investment- firm must decide if its economical
many sunk costs are inevitable- update machinery, research, advertising
fixed costs
do not vary
only way to eliminate - completly shut down- sell off/ scrap machinery, sell site etc
affect the firm's decisions
variable costs
vary
total cost
fixed + variable
over
short term
- most costs are
fixed
. Over a
long time
(10 years) most costs are
variable
Amortization
treating one-time costs as cost paid over number of years- installments
Marginal Cost
increase in TC from an extra unit of output
Diminishing marginal returns-> MPL declines as quantity of labour increases
Marginal cost will increase as output increases
average costs- cost/quantity (ATC= TC/Q)
Cost in the short run
marginal cost crosses at lowest points of ATC & AVC
important for firms that operate in a evironment that conditions change frequently
Costs in the long run
user cost of capital
annual cost of owning & using a capital asset
User Cost of Capital = Economic Depreciation + (InterestRate)(Value of Capital)
also expressed as rate per dollar of capital
𝑟=Depreciation rate+Interest rate
cost minimizing
capital
can be adjusted
firm must decide prospectively how much capital to get
expressed as a flow- euros per year
must amortize the expenditure- spread over the lifetime of the capital
Isocost line
shows all combinations of labor and capital that can be purchased
slope
ΔK/ΔL = −(𝑤∕𝑟)
Long-run vs Short-run cost curves
short run
hard to minimize costs due to inflexability
long run
able to reduce costs- ability to change amount of capital
long run average cost curve
relates average cost of production to output when all inputs are variable
short run average cost curve
relates average cost of production to output when level of capital is fixed
long run marginal cost curve
shows the change in long run TC as output is increases incrementally by 1 unit
economies and diseconomies of scale
output increases- AC decreases
larger scale- workers specialize in acitvites they are most productive at
2.scale can improve flexability- organise production process more efficiently
acquire materials at lower cost- buying in large quantities- negotiate better prices
AC increases with output
short run- factory space/ machinery- more difficult for workers to work efficiently
managing larger firm- more complex
advantages of buying in bulk may dissapear once certain quantities are reached- certain materials may be limited
