Chapter 7 - Cost of production Flashcards
Define accounting cost
Accounting cost is the actual expenses plus depreciation for capital equipment periodized
Defiene economic cost
Cost to a firm of utilizing economic resources in production. Forward looking.
Economic costs are those costs that are relevant to a certain decision.
Elaborate on opportunity cost
The cost of using something in regards to its best alternative usage. For instance, a building could be leased instead of being used for office etc.
What is the most important thing about opportunity cost and economic cost?
Forward looking. Always in the future.
Decisions based: Always relevant for the decision to be made.
Define marginal costs:
The additional cost of producing 1 additional unit.
MC = deltaVC/deltaq = deltaTC/deltaq
MC = dVC/dq = dTC/dq
Define average cost/average total cost
Average cost is the total cost of production divided by the amount of units in output. Gives the average cost per unit produced.
AC = TC/q
AC has two components;
1) AVC
2) AFC
In all cases, average costs, total costs, variable costs, fixed costs, are usually given as dollars per year or something similar.
What’s important to consider regarding fixed costs when seen in a long run perspective?
In the long run, all costs are variable.
How can we develop marginal cost to include wages?
The point here is that when we have only one variable input, we can quickly define the marginal cost.
The marginal cost is equal to the price of that variable input unit, divided by the marginal productivity of that input.
MC = priceOfinputUnit / MP_{inputUnit}
If the variable input is labor, then we have the following:
MC = w / MP_{L}
Assume we talk about units of labor in hours. Let us say the price of one unit of labor is 30 usd. That takes care of the w.
MP_{L} = change in output divided by change in labor. Meaning, the additional output we get for an additional unit of labor. Let us say one unit of labor gives us output of 10 (additional output). Then the marginal cost is equal to 30/10 = 3. This is basic shit. This is the marginal cost! Remember that marginal cost is the additional cost required to create/produce one additional unit. When we added the labor unit of 1 hour, this unit gives us 10 units extra output. We need to accommodate for this and get the shit over at the form of cost per additional OUTPUT.
Cost of producing one more output-unit is equal to the price of one extra input-unit divided by the amount of extra output-units this extra input-unit delivers.
EXTRA FORMULATIONS: NOT UPDATED; NOT SURE HOW GOOD
Recall that marginal cost is the additional cost required to produced one more unit. If we look at labor as the only way of regulating output, we can consider this: fixed wage w, change in labor dL.
MC = dTC/dq (Change in costs per change in output)
MC = dTC/dq = dVC/dq (VC = TC because fixed costs are not relevant in marginal costs)
MC = dVC/dq = w(dL/dq), because wdL = dVC
MC = w*(dL/dq) = w * MP_{L}^(-1)
MC = w/MP_{L}
Meaning, the marginal cost (additional cost of 1 more unit) is equal to the wage divided by the marginal productivity of labor, which is the additional output we get by adding one more unit of labor. The larger the output per labor is, the lower the marginal costs will be. If the output per labor is really small, the marginal costs will be huge.
This is essentially just a way of saying that the cost of producing one extra unit is dependent on how much output the extra labor needed will deliver.
ADDITIONAL EXPLANATION; NOT SURE HOQW GOOD
Marginal cost is the additional cost to produced one more unit.
This additional cost must be variable. If we assume the firm can hire as much labor as it wants to fixed wages “w”, then deltaVC = w*deltaL
MC = dVC/dq = w*dL/dq
MC = w/MP_{L}
In other words, the marginal costs is equal to the wage divided by the marginal productivity of labor
Why does a firm have more flexibility in the long run than in the short run? I am thinking in regards to actual real life things
In the long run the firm may change machinery, buy new equipment, expand contract and initiate new ones etc.
What is the “user cost of capital”
Annual cost of owning and using a capital asset. Equal to economic depreciation + interest rate*ValueOfCapital.
Interest rate is because of the fact that this money could be used to earn interest instead.
What is the “rate” per dollar of capital?
r = depreciation rate + interest rate
Depreciation rate is the rate of depreciation (Lmao) meaning how fast it depreciates. If we buy a plane that we believe will last 30 years, the depreciation rate is 1/30 = 3.33 percent.
Interest rate is whatever rate we could get on our money elsewhere. Let us say we can get 10% elsewhere.
Therefore, our rate would be equal to 3.33 + 10 = 13.33%.
This rate is an opportunity cost rate, and you’ll have to compare this percentage for all alternatives to figure out whether the cost of capital is good or not. You’d want to pick the lowest, because that one offers the best revenue to cost ratio.
When we are trying to figure out how to select inputs to produce a given output at minimum cost, what do we work with in terms of inputs?
(ignore)
We consider labor in hours and capital in hours of machine time.
Define isocost line
An isocost line shows all possible combinations of inputs that can be purchased for a given total cost.
C = wL + rK
We can rewrite this like we do with the budget line:
K = C/r - (w/r)*L
This is obviously a linear curve with intercept C/r and slope -w/r
How do we choose inputs to produce at some output level at minimum cost?
The intersect point (only one, not two) where the isoquant curve representing a level of output interests an isocost line will represent the point where the cost-minimized combination of inputs are. If the output level is import, we adjust the isocost line by shifting it until we reach the tangency point. If the budget is most important, we figure out where the isoquant curve is that intersects the isocost line at only one point. This yield the best use of our inputs.
If the level of output is most important, then use the isoquant curve that shows all combinations yielding this number of output. Then we enter the isocost line and shifts it until it intersects the isoquant line in exactly one point and stands tangent. At this point we know that we have used the lowest possible isocost line to produce the specific output.
If the budget is more important, we use the isocost line to show our furthest budget, and then find the isoquant curve that intersects isocost in only one point.
Elaborate on the expansion path of a firm
The expansion path is a tracer curve that shows the cost-minimized combination of inputs for each level of output. Therefore, this path is the best path to choose input combinations from.
The expansions path is a curve that trace the points where an isoquant intersect an isocost curve at exactly one point. Therefore, the expansion path shows the best / cost minimized option, or cost minimized combination of inputs, for each level of output. In other words, the expansion path shows the combinations of labor and capital that the firm will choose to minimize its costs at each output level.
the expansion path shows the firm what it has to set its inputs to if it wants to get output to a certain level.
What is the cost curve/long run cost curve?
How is it created?
The long run cost curve is a curve that shows the cost associated with different levels of output.
We can create it by using the expansion path.