1 / 37

PPA 723: Managerial Economics

PPA 723: Managerial Economics. Lecture 11: Costs. Managerial Economics, Lecture 11: Costs. Outline Short-Run Cost Curves The Input Mix Decision Long-Run Cost Curves. Managerial Economics, Lecture 11: Costs. Review Short run production concepts: Total, average, and marginal products.

varana
Download Presentation

PPA 723: Managerial Economics

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. PPA 723: Managerial Economics Lecture 11: Costs

  2. Managerial Economics, Lecture 11: Costs Outline • Short-Run Cost Curves • The Input Mix Decision • Long-Run Cost Curves

  3. Managerial Economics, Lecture 11: Costs • Review • Short run production concepts: • Total, average, and marginal products. • MPL=APL at maximum APL • Law of Diminishing Marginal Returns • Long-run production concepts • Isoquant • MRTS = MPL/MPK • Returns to Scale

  4. Managerial Economics, Lecture 10: Production

  5. Managerial Economics, Lecture 11: Costs From Production to Cost • Production concepts examine the amount of input(s) needed to produce a given output. • Cost concepts examine the cost of the inputs needed to produce a given output. • Thus cost concepts combine production concepts with input prices.

  6. Managerial Economics, Lecture 11: Costs Short-Run Cost Measures • Fixed cost (F): production expense that does not vary with output. • Variable cost (VC): production expense that changes with quantity of output produced. • Total cost (C): C = VC + F

  7. Managerial Economics, Lecture 11: Costs Average Cost Concepts • Average fixed cost: AFC = F /q • Average variable cost: AVC = VC /q • Average (total) cost: AC = C/q = AFC + AVC

  8. Managerial Economics, Lecture 11: Costs Marginal Cost • Marginal cost, MC, is the cost of producing the last unit • MC is the change in cost, C, when output changes by q • That is, MC = C/q

  9. Managerial Economics, Lecture 11: Costs Sunk Fixed Cost • We usually assume fixed cost is sunk, i.e., expenditure that cannot be recovered. • The opportunity cost of capital is zero • because you can't get this expenditure back no matter what you do. • So ignore it when making decisions • Example: walk out of a bad movie early, regardless of what you paid to attend • Otherwise, fixed cost is called avoidable.

  10. Managerial Economics, Lecture 11: Costs

  11. (a) Managerial Economics, Lecture 11: Costs Cost, $ 400 C VC 27 A 1 216 Figure 7.1 Short-Run Cost Curves 20 1 B 120 48 F 0 2 4 6 8 10 Quantity, q , Units per day (b) Cost per unit, $ 60 MC AC a 28 27 AVC b 20 8 AFC 0 2 4 6 8 10 Quantity, q , Units per day

  12. Managerial Economics, Lecture 11: Costs MC, AC, and AVC Curves • AC and AVC curves fall when MC is below them, and rise when MC is above them. • Therefore, the MC curve intersects the AC and AVC curves at their minimum points.

  13. Managerial Economics, Lecture 11: Costs Example • Suppose the short-run cost function is • C = 125 + 2q + q2 • What are the: • fixed cost • variable cost • average cost • average fixed cost • average variable cost?

  14. Managerial Economics, Lecture 11: Costs Answer If C = 125 + 2q + q2 Fixed cost = F = 125 Variable cost = VC = 2q + q2 Average cost = AC = C/q = 125/q + 2 + q Average fixed cost = AFC = 125/q Average variable cost = AVC = 2 + q Note: marginal cost = MC = 2 + 2q

  15. Managerial Economics, Lecture 11: Costs Production Functions & Cost Curves • A production function shows the inputs needed to produce a given output. • A firm's cost is found by multiplying the quantity of each input by its price and summing across inputs. • Higher average or marginal productivity implies lower average or marginal cost, so cost curves are U-shaped—the inverse of product curves.

  16. Managerial Economics, Lecture 11: Costs Application Short-Run Cost Curves for a Printing Firm (with continually rising AVC) Cost, kroner 50 MC 40 30 AC AVC 20 10 AFC 0 100 200 300 q , Units per year

  17. Managerial Economics, Lecture 11: Costs Cost Effects of $10 Tax • This tax affects variable but not fixed cost • After-tax (a) cost = before-tax (b) cost + 10q: Ca = Cb + 10q • At every quantity, AVC, AC, and MC curves shift up by $10: AVCa = AVCb + $10 ACa = ACb + $10 MCa = MCb + $10

  18. Managerial Economics, Lecture 11: Costs Figure 7.3 Effects of a Specific Tax on Cost Curves Costs per unit, $ a b MC = MC + 10 80 b MC $10 a b AC = AC + 10 37 b $10 AC 27 0 5 8 10 15 q , Units per day

  19. Managerial Economics, Lecture 11: Costs Long-Run Costs • A firm adjusts all its inputs so its cost of production is as low as possible. • If capital and other variable costs can be varied, LR fixed costs equal zero (F = 0). • Thus LR total cost = LR variable cost: C = VC

  20. Managerial Economics, Lecture 11: Costs Input Choice • To understand LR cost curves, we must examine a firm’s input mix decision. • A firm chooses from all technologically efficient combinations of inputs, the economically efficient combination of inputs.

  21. Managerial Economics, Lecture 11: Costs The Iso-Cost Line • Isocost line: all combinations of inputs that require the same (iso) total expenditure (cost). • If cost is C = wL + rK • then isocost is • where is a fixed level of cost • An isocost line is analogous to a budget constraint.

  22. Managerial Economics, Lecture 11: Costs K , Units of Figure 7.4 A Family of Isocost Lines capital per year $150 = 15 — — — $ 10 $100 e = 10 — — — $ 10 d c $50 = 5 — — — $10 b $ 50 isocost $100 isocost $150 isocost a $50 $100 $150 = = = — — — 10 — — — 20 — — — 30 $ 5 $ 5 $ 5 L , Units of labor per year

  23. Managerial Economics, Lecture 11: Costs Properties of Isocost Lines • The intercepts depend on factor prices. • intersects capital axis at • intersects labor axis at • Isocosts farther from origin involve higher costs. • The slope of each isocost line is the same. • As with a budget line, the slope is the price of the factor on the horizontal axis divided by the price of the factor on the vertical axis. • That is, slope = K/L = -w/r

  24. Managerial Economics, Lecture 11: Costs Minimizing Costs • To pick lowest-cost combination of inputs to produce a given level of output when isoquants are smooth: • Pick the lowest possible isocost line that touches the relevant isoquant. • The isocost and isoquant lines are tangent at this point, that is, MRTS = w/r

  25. Managerial Economics, Lecture 11: Costs Figure 7.5 Cost minimization for Norwegian printing firm K , Units of q = 100 isoquant capital per year 3,000-kr isocost y 303 2,000-kr isocost 1,000-kr isocost x 100 z 28 0 24 50 116 L , Units of labor per year

  26. Managerial Economics, Lecture 11: Costs Last Dollar Rule • As in the case of utility maximization, this analysis leads to a last dollar rule: make sure the last dollar spent on one input produces as much extra output as last dollar spent on any other input

  27. Managerial Economics, Lecture 11: Costs Cost Minimizing vs. Output Maximizing • With smooth isoquants: firm determines best factor proportions by either • Minimizing cost: what is the lowest cost, C*, at which the firm can produce output q*? • Maximizing output: What is the most output, q*, that can be produced at cost C*?

  28. Managerial Economics, Lecture 11: Costs Long-Run Cost • Examine the lowest-cost factor combination for various levels of output • Define the expansion path: • Defined by cost-minimizing combination of labor and capital for each output level • The curve through tangency points is LR expansion path • The expansion path shows same relationship between LR cost and output as the LR cost curve.

  29. Managerial Economics, Lecture 11: Costs Figure 7.7a Expansion Path and Long-Run cost Curve (a) 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 100 200 isoquant 150 isoquant 100 isoquant 0 50 75 100 L , Workers per year

  30. Managerial Economics, Lecture 11: Costs Figure 7.7b Expansion Path and Long-Run cost Curve (b) Long-Run Cost Curve Long-run cost curve C , Cost, kroner 4,000 Z 3,000 Y 2,000 X 0 100 150 200 q , Units per year

  31. Managerial Economics, Lecture 11: Costs Shape of LR Cost Curves • Short-run: • SR AC initially downward sloping because AFC is downward sloping • SR AC later upward sloping because of diminishing returns • Long-run • No fixed cost in LR (usually) • Shape of cost curves determined by production function returns to scale.

  32. Managerial Economics, Lecture 11: Costs (a) Cost Curve Cost, $ C Figure 7.8 Long-Run Cost Curves q * q , Quantity per day (b) Marginal and Average Cost Curves Cost per MC unit, $ AC q * q , Quantity per day

  33. Managerial Economics, Lecture 11: Costs Economies of Scale

  34. Managerial Economics, Lecture 11: Costs Long-Run & Short-Run Cost Curves • In LR, firm chooses optimal plant size to minimize its LR cost for a given q • Because the firm cannot vary its capital in SR but can in LR • SR cost  LR cost • SR cost > LR cost if the "wrong" level of capital is used in SR

  35. Managerial Economics, Lecture 11: Costs Figure 7.9 Long-Run Average Cost as the Envelope of Short-Run Average Cost Curves Average cost, $ LRAC 3 SRAC 2 SRAC 1 3 SRAC SRAC b 12 d 10 a c e 0 q q q , Output per day 1 2

  36. Managerial Economics, Lecture 11: Costs Long-Run Cost Curves in Printing Cost, kroner 40 1 SRAC 2 SRMC 1 SRMC 30 2 SRAC 20 = LRAC LRMC 10 0 200 600 1,200 q , Output per year

  37. Managerial Economics, Lecture 11: Costs Long-Run Cost Curves Oil Pipelines Cost per barrel-mile 150 100 8 " SRAC 10 " SRAC 12 " SRAC 50 16 " SRAC 20 SRAC " 26 " SRAC SRAC " 40 10 LRAC 0 10 20 40 100 200 400 1000 2000 Thousand barrels per day

More Related