3_Cost functions Flashcards
What is the Total cost function ?
- Total cost function is the relationship between output levels and the lowest possible costs of producing and selling this output (given a firm’s current technology)
- The total cost function assumes efficient production
- Therefore, it has to increase in output!
- Part of the costs is fixed, part is variable
What includes the Total Cost ?
(mathematical calculation)
Total Cost = Fixed Costs + Variable Costs
- Fixed costs (FC) are costs that remain constant as output increases
- independent of the output e.g. rent
- e.g. paying agency for advertisement
- Variable costs VC(Q) are costs that increase as output increases
- e.g.StickK case: credit card fees were the variabel costs
- e.g. costs for making the flyers the agency developped
- Costs may also be semi-fixed = fixed over output intervals
- e.g. small truck can deliver 500L bier by day. From zero to 500 it is thus a fixed cost. Above it is a semi fixed cost (if they buy a bigger truck)
- eg. monthly phone subscription if monthy fixed but with time you could switch to a different type of contract. On the short term it is fix but on the long run, you might one could switch contract
On what does it depend if a cost is fixed or variable ?
Wether a cost is fixed or variable, it depends on the chose time frame!
Fixed Costs can be infulenced by management decisions
e.g.advertizing is fixed but a management could change it
Are “fixed costs” and “variable costs” always the same for the company?
Give examples
No, because the distinctinction between fixed costs and variable costs ist often a bit fuzzy.
- costs may be semi-fixed, meaning: fixed over output intervals.
Example bier brewery:
The Truck can deliver 500L by day. If the company wants to deliver more, then they need a bigger truck which will mean higher costs and this truck may carry 1000L.
From 0 to 500, fixed costs are the same (because of use of the same truck)
From 600 to 1000 the FK will be higher. Above 500 L it is an other price < semi fixed costs
2. Wether a cost is fixed or variable depends on the chosen time frame
Example monthly phone subscription:
It is monthly fixed. But with time you could switch to a different type of contract. In the short runt it can be fixed but on the longer run one could switch contract.
Thus,wether a cost is fixed or variable, depends on the chosen time frame.
3. Fixed costs can be influenced by management decisions
Example: Advertizing is fixed but management could change it.
What is “average cost”?
Does it have an other name ?
How do you write (in algebra and mathematicaly)?
- Average cost = Total cost / Quantity (produced)
- average of cost are also sometimes called per-unit cost
- To indicate that the average cost does often change with output Q, we write AC(Q)
- AC(Q) = FC/Q + VC(Q)/ Q
- AC(Q) = Average fix cost + Average variable cost
- fix costs do not change with output of Q, they must decrease with additional output produced
- variable costs depend on Q !
What is the process called, when Average cost does not vary with output ?
Average cost (AC) often vary with output.
If it does not, the make and sell process has constant returns to scale
What does “economies of scale” mean ?
What is the effect on Marginal Costs and Average Costs ?
When average cost decrease with output, there are “economies of scale”.
When AC decreases => MC < AC
Example: 10 unites costs 3§ but the 11th unit costs 2§
What is diseconomies of scale ?
And what is its effect on Marginal Costs and Average Costs ?
When Average Cost increase with output, there are diseconomies of scale.
AC increases => MC > AC
Each additional unit produced will be more expensive than the previous produced units
What is the Minimum Efficient Scale (MES)?
Minimum efficient scale of a firm is where all economies of scale have already been exhausted
MES was in the example Q’
Smaller output level that fully exploits all economies of scale.
Groing beyond Q’ up to Q’’, there is no decrease of the average cost (= constant economy of scale - AC does not vary, the line is flat)
What are marginal costs ?
(mathematically seen)
- Marginal cost (MC) = Rate of change in total cost with respect to output
- Assume output is currently Q and we are interested in the change in Total Cost if we now produce one more unit
- Change in Output = 1 (∆Q)
- Change in TC= TC (Q + ∆Q) - TC (Q)
- MC(Q) = (TC= TC (Q + ∆Q) - TC (Q)) / ∆Q
MC function just gives the slop of the TC at different levels of Q.
The steaper the slot of Q in Total Cost > the steaper it also gets in the marginal cost
When do you look at an average long-run average cost function (LAC) or short run average cost function (SAC)?
- The long-run average cost function is what matter when choosing which size (e.g. Restaurant) given the intended output.
- For a given size, firms operate on the short run average cost function (SAC) (e.g small restaurants have to have a small curve - they have to reduce the costs curves)
- When looking at three different sizes (e.g. of Restaurants), the LAC is the lower envelope of the three SACs, it looks at the most efficient of all options.
- The key to achieve the lower envelope is not the production plant size, but also reaching the output level that is necessary for this size to be most efficient
What are accounting costs and what do they help for ?
Accounting costs are historical costs and
help measure the past performance of firms
What are economic costs of a resource?
Economic costs of a resource incorporate its value in the best foregone use (opportunity costs).
Economic costs = accounting costs + opportunity costs
not only do you look at accounting costs but also at how else somebody could have used this resource.
Good economic decisions consider opportunity costs !
What is accounting profit mathematically ?
Accounting profit = Sales – Accounting costs
What is economic profit (mathematically) ?
How does economic costs and economic profit differ from accounting costs and accounting profit ?
Economic profit = Sales – Economic costs
Economic profit = Accounting profit – (Economic cost – Accounting cost)
FYI: Economic costs = accounting costs + opportunity costs.
- FYI: Economic costs - accounting costs = opportunity costs.*
- So we could say : economic profit = accounting profit - opportunity costs ?*
FYI: Accounting profit = Sales – Accounting costs
–> Economic costs and profit differ from accounting costs and profit through inclusion of opportunity costs
