Cost Functions

1. Cost Functions • Short run – at least one factor of production is fixed • Long run – all factors of production can vary • Fixed costs – associated with payments to fixed variable(s) of production • Variable costs – associated with payments to varying factor(s) of production • In class we will mostly discuss short run production decision making

2. Costs per unit of output • AC or ATC • Average total cost : TC/Q • AFC • Average fixed cost: AFC/Q • AVC • Average variable cost: AVC/Q • AC = AFC + AVC

3. Cost per unit of output • MC • Marginal cost = dTC/dQ = dVC/dQ • Measure of efficiency • Production where AC is a minimum • Firms do not seek to produce at maximal efficiency – market forces, however, can least to efficiency

4. Cost per unit of output • If AC is declining throughout a relevant range of production then a firm might have a natural monopoly (more on this) • If AC has a minimum then MC = AC at that point of production

5. Shape of cost • The shape of the cost function is a reflection of the firm’s production function • Graphical analysis • Numeric analysis