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Costs
Perloff Chapter 7
Economic cost
• business (accounting) costs: only explicit costs (out of pocket)
• economic costs: explicit cost + implicit cost = opportunity cost
• opportunity cost– value of best alternative use of the resource
– classic example: "There's no such thing as a free lunch"
Short-run costs
Source: Perloff
Short-run cost curves
120
216
400
48
0 6 10
10
42 8Quantity, q, Units per day
Quantity, q, Units per day6
b
a
B
A
42 8
C
F
1
1
27
20
VC
MC
AC
AVC
AFC
Cost, $
60
2827
20
8
0
Source: Perloff
Total product curve and VCQuantity, q,
Units per day
24120
46230
20100
525
77385
Total product of labor,Variable cost
L, Hours of labor per dayVC = wL, Variable cost, $
0
5
1
6
10
13
Source: Perloff
Shape of MC and AC curve
q
VCMC
q
LwMC
LMP
wMC
q
VCAC
q
wLAC
LAP
wAC
The long-run: input choice
rKwLC Lr
w
r
CK
Source: Perloff
Isocost LinesK, Units of
capital per year
a
b
d
e
c
$150 isocost$100 isocost$50 isocost
$100———
$5= 20
$150———
$5= 30
$50———$5
= 10
$100———$10
10 =
$50———$10
5 =
$150———$10
15 = Lr
w
r
CK
, Units of labor per yearSource: Perloff
Cost minimisationK, Units of
capital per year
y
x
z
11650240L , Units of labor per year
100
303
28
q = 100 isoquant
3,000-krisocost
2,000-krisocost
1,000-krisocost
Lowest isocost ruleTangency rule
Source: Perloff
Three (equivalent) rules for cost minimisation
1. Lowest Isocost
2. Tangency
K
L
MP
MP
r
wMRTS
3. Last dollar rule (equimarginal returns)
r
MP
w
MP KL
Cobb-Douglas example
K
qMP
L
qMP
KLq
K
L
4.0
6.0
52.1 4.06.0
K, Units of
capital per year
y
x
z
11650240
L, Units of labor per year
100
303
28
At X:
05.024
2.1
2.150
1006.0
w
MP
MP
L
L
05.08
4.0
4.0100
1004.0
w
MP
MP
K
K
At Y:
1.024
5.2
5.224
1006.0
w
MP
MP
L
L
016.08
13.0
13.0303
1004.0
w
MP
MP
K
K
Source: Perloff
Factor price changesK, Units of
capital per year
v
x
77500 L, Workers per year
100
52
q = 100 isoquant
Originalisocost,2,000 kr
New isocost,1,032 kr
Source: Perloff
Expansion pathK, Units of
capital per year
x
y
z
10075500 L, Workers per year
150
200
100
Expansion path
3,000-krisocost
2,000-krisocost
4,000-kr isocost
100 isoquant150 isoquant
200 isoquant
Source: Perloff
Long run total cost curveC, Cost, kroner
X
Y
Z
0 q, Units per year
4,000
3,000
2,000
Long-run cost curve
200100 150
Source: Perloff
Returns to scale and LACK, Units of
capital per year
41 2
a
b
c
a b: Increasing returns to scale
b c: Constant returns to scale
c d: Decreasing returns to scale
8 L, Work hours per year
4
2
1
0
8
q = 8
q = 6
q = 3q = 1
d
Source: Perloff
Returns to scale and LAC (cont)
Source: Perloff
Long and short run expansionK, Capital
per year
100
x y
z
50 159
Long-run expansion path
200 isoquant
100 isoquant
Short-runexpansion path
4,616 kr
4,000 kr
2,000 kr
L , Workers per year0
100
200
Source: Perloff
Relationship between LAC and SAC
Average cost, $
a
bd
e
SRAC1 SRAC 2SRAC3
SRAC 3LRAC
c
q2q1 q, Output per day
10
0
12
Source: Perloff
Learning by doing
Improvements in productivity which result from knowledge and experience
Average cost
A
BC
b
c
q, Output per period
Learning by doing
Economies of scale
q2 q3
AC 3
AC 2
AC1
q1
Source: Perloff
