The%20Firm%20and%20Cost

1
The Firm and Cost Overheads
2
Costs in the short run
Total cost
A firms total cost of production is
the opportunity cost of the owners
everything they must give up in order to
produce output
3
Explicit and implicit costs
Explicit costs
1. purchase of expendable inputs including labor
time
2. purchase of capital services (usually rent or
lease)
Implicit costs
1. value of produced expendables (feed for a
cattle producer)
2. value of services provided by owned capital
including financial capital
4
Operating costs and allocated overhead
1. Costs of all expendables are often allocated
to the generic group OPERATING COSTS
2. All other costs are allocated to the group
ALLOCATED OVERHEAD
5
Data for the hay hauling problem
Cost of labor per hour w1 6.00
Cost of tractor-wagon per hour w2 20.00
6
Total fixed cost (TFC)
The cost of all inputs that are fixed in the
short run are called total fixed costs
Assume that wagons hours is fixed at 1
For this example, then TFC 20.00
7
Graphical representation
100
Fixed Cost Curve
Cost
80
60
40
20
0
0
400
800
1200
1600
2000
2400
Output - y
8
Data on hay hauling
x1 x2 TPP APP A MPP MPP TFC TVC TC AFC AVC ATC A
MC MC 0.00 1.00 0.00 0.00 20.0 0.00 20.00

1.0 1.0 38.0 38.00 38.00 74.0 20.0 6.00
26.00 0.526 0.158 0.684 0.158 0.081
2.0 1.0 144.0 72.00 106.00 136.0 20.0 12.00
32.00 0.139 0.083 0.222 0.057 0.044
3.0 1.0 306.0 102.00 162.00 186.0 20.0 18.00
38.00 0.065 0.059 0.124 0.037 0.032
9
Data on hay hauling
x1 x2 TPP APP A MPP MPP TFC TVC TC AFC AVC ATC A
MC MC 0.00 1.00 0.00 0.00 20.0 0.00 20.00

1.0 1.0 38.0 38.00 38.00 74.0 20.0 6.00
26.00 0.526 0.158 0.684 0.158 0.081
2.0 1.0 144.0 72.00 106.00 136.0 20.0 12.00
32.00 0.139 0.083 0.222 0.057 0.044
3.0 1.0 306.0 102.00 162.00 186.0 20.0 18.00
38.00 0.065 0.059 0.124 0.037 0.032
4.0 1.0 512.0 128.00 206.00 224.0 20.0 24.00
44.00 0.039 0.047 0.086 0.029 0.027 5.0 1.0 750.
0 150.00 238.00 250.0 20.0 30.00 50.00
0.027 0.040 0.067 0.025 0.024 6.0 1.0 1008.0 168.
00 258.00 264.0 20.0 36.00 56.00
0.020 0.036 0.056 0.023 0.023 7.0 1.0 1274.0 182.
00 266.00 266.0 20.0 42.00 62.00
0.016 0.033 0.049 0.023 0.023 8.0 1.0 1536.0 192.
00 262.00 256.0 20.0 48.00 68.00
0.013 0.031 0.044 0.023 0.023 9.0 1.0 1782.0 198.
00 246.00 234.0 20.0 54.00 74.00
0.011 0.030 0.042 0.024 0.026 10.0 1.0 2000.0 200
.00 218.0 200.0 20.0 60.00 80.0
0.010 0.030 0.040 0.028 0.030 11.0 1.0 2178.0 198
.00 178.0 154.0 20.0 66.00 86.0
0.009 0.030 0.039 0.034 0.039 12.0 1.0 2304.0 192
.00 126.0 96.0 20.0 72.00 92.0
0.009 0.031 0.040 0.048 0.063 13.0 1.0 2366.0 182
.00 62.0 26.0 20.0 78.00 98.0
0.008 0.033 0.041 0.097 0.231 14.0 1.0 2352.0 168
.00 -14.0 -56.0 20.0 84.00 104.0
0.009 0.036 0.044
10
Total variable cost (TVC)
Remember that the cost of all the inputs that are
variable in the short run is called total
variable cost
For our example TVC(38) 6.00
11
Data on hay hauling
x1 x2 TPP APP A MPP MPP TFC TVC TC AFC AVC ATC A
MC MC 0.00 1.00 0.00 0.00 20.0 0.00 20.00
1.0 1.0 38.0 38.00 38.00 74.0 20.0 6.00
26.00 0.526 0.158 0.684 0.158 0.081 2.0 1.0 144.0
72.00 106.00 136.0 20.0 12.00 32.00
0.139 0.083 0.222 0.057 0.044 3.0 1.0 306.0 102.0
0 162.00 186.0 20.0 18.00 38.00
0.065 0.059 0.124 0.037 0.032
And TVC (306) 18.00
12
Data on hay hauling
x1 x2 TPP APP A MPP MPP TFC TVC TC AFC AVC ATC A
MC MC 0.00 1.00 0.00 0.00 20.0 0.00 20.00
1.0 1.0 38.0 38.00 38.00 74.0 20.0 6.00
26.00 0.526 0.158 0.684 0.158 0.081 2.0 1.0 144.0
72.00 106.00 136.0 20.0 12.00 32.00
0.139 0.083 0.222 0.057 0.044 3.0 1.0 306.0 102.0
0 162.00 186.0 20.0 18.00 38.00
0.065 0.059 0.124 0.037 0.032 4.0 1.0 512.0 128.00
206.00 224.0 20.0 24.00 44.00
0.039 0.047 0.086 0.029 0.027 5.0 1.0 750.0 150.0
0 238.00 250.0 20.0 30.00 50.00
0.027 0.040 0.067 0.025 0.024 6.0 1.0 1008.0 168.
00 258.00 264.0 20.0 36.00 56.00
0.020 0.036 0.056 0.023 0.023 7.0 1.0 1274.0 182.
00 266.00 266.0 20.0 42.00 62.00
0.016 0.033 0.049 0.023 0.023 8.0 1.0 1536.0 192.
00 262.00 256.0 20.0 48.00 68.00
0.013 0.031 0.044 0.023 0.023 9.0 1.0 1782.0 198.
00 246.00 234.0 20.0 54.00 74.00
0.011 0.030 0.042 0.024 0.026 10.0 1.0 2000.0 200
.00 218.0 200.0 20.0 60.00 80.0
0.010 0.030 0.040 0.028 0.030 11.0 1.0 2178.0 198
.00 178.0 154.0 20.0 66.00 86.0
0.009 0.030 0.039 0.034 0.039 12.0 1.0 2304.0 192
.00 126.0 96.0 20.0 72.00 92.0
0.009 0.031 0.040 0.048 0.063 13.0 1.0 2366.0 182
.00 62.0 26.0 20.0 78.00 98.0
0.008 0.033 0.041 0.097 0.231 14.0 1.0 2352.0 168
.00 -14.0 -56.0 20.0 84.00 104.0
0.009 0.036 0.044
13
Graphical representation of TVC
100
Total Variable Cost
Cost
80
60
40
20
0
0
400
800
1200
1600
2000
2400
Output - y
14
Total cost (TC)
The cost of all inputs used by the firm is
called total costs
Specifically, the sum of fixed and variable
costs is called total costs
TC TFC TVC
15
Cost function
16
Graphical representation of total cost (TC)
Total Cost Curves
100
Cost
80
60
40
20
0
0
400
800
1200
1600
2000
2400
Output - y
17
Average cost (AC)
Average cost is just a total cost figure divided
by the associated output level
AC represents the average per unit cost of a
given level of output
There are average costs associated with
each level of total costs
18
Average fixed cost is given by
Average variable cost is given by
Average (total) cost is given by
19
Data on hay hauling
x1 x2 TPP(y) APP A MPP MPP TFC TVC TC AFC AVC AT
C AMC MC 0.00 1.00 0.00 0.00 20.0 0.00
20.00 1.0 1.0 38.0 38.00 38.00 74.00
20.0 6.00 26.00 0.526 0.158 0.684 0.158 0.081
2.0 1.0 144 72.00 106.0 136.0 20.0 12.0 32.0
0.139 0.083 0.222 0.057 0.044 3.0 1.0 306.0 102.0
0 162.00 186.00 20.0 18.00 38.00
0.065 0.059 0.124 0.037 0.032 4.0 1.0 512.0 128.0
0 206.00 224.00 20.0 24.00 44.00
0.039 0.047 0.086 0.029 0.027 5.0 1.0 750.0 150.0
0 238.00 250.00 20.0 30.00 50.00
0.027 0.040 0.067 0.025 0.024 6.0 1.0 1008.0 168.
00 258.00 264.00 20.0 36.00 56.00
0.020 0.036 0.056 0.023 0.023 7.0 1.0 1274.0 182.
00 266.00 266.00 20.0 42.00 62.00
0.016 0.033 0.049 0.023 0.023 8.0 1.0 1536.0 192.
00 262.00 256.00 20.0 48.00 68.00
0.013 0.031 0.044 0.023 0.023 9.0 1.0 1782.0 198.
00 246.00 234.00 20.0 54.00 74.00
0.011 0.030 0.042 0.024 0.026 10.0 1.0 2000.0 200
.00 218.0 200.00 20.0 60.00 80.0
0.010 0.030 0.040 0.028 0.030 11.0 1.0 2178.0 198
.00 178.0 154.00 20.0 66.00 86.0
0.009 0.030 0.039 0.034 0.039 12.0 1.0 2304.0 192
.00 126.0 96.00 20.0 72.00 92.0
0.009 0.031 0.040 0.048 0.063 13.0 1.0 2366.0 182
.00 62.0 26.00 20.0 78.00 98.0
0.008 0.033 0.041 0.097 0.231 14.0 1.0 2352.0 168
.00 -14.0 -56.00 20.0 84.00 104.0
0.009 0.036 0.044
20
Average Fixed Cost
0.8
Cost
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
0
400
800
1200
1600
2000
2400
Output - y
21
Average Variable Cost
0.20
Cost
0.15
0.10
0.05
0.00
0
400
800
1200
1600
2000
2400
Output - y
22
Average Cost Curves
0.40
Cost
0.30
0.20
0.10
0.00
0
400
800
1200
1600
2000
2400
Output - y
Note that ATC AVC AFC
23
Marginal cost
Marginal cost is the increment, or addition, to
cost that results from producing one more unit of
output
The increase in total cost is the increase in
variable cost
In discrete or average terms marginal cost is
given by
24
Marginal cost is just the derivative of the cost
function with respect to y
25
Example calculation
x1 x2 y TFC TVC TC AVE MC 0.0 1.0 0.0 20.0 0.00
20.00 1.0 1.0 38.0 20.0 6.00 26.00
0.158 2.0 1.0 144.0 20.0 12.00 32.00
0.057 3.0 1.0 306.0 20.0 18.00 38.00
0.037 4.0 1.0 512.0 20.0 24.00 44.00
0.029 5.0 1.0 750.0 20.0 30.00 50.00
0.025 6.0 1.0 1008.0 20.0 36.00 56.00 0.023
26
Graphical representation of Marginal Cost
0.20
Cost
0.15
0.10
0.05
0.00
0
400
800
1200
1600
2000
2400
Output - y
27
Relationship between MC MPP (1 variable input)
When MPP rises, MC falls
When MPP falls, MC rises
Marginal Cost Curve
Marginal Product of Input 1
0.20
300
Cost
Output - y
250
0.15
200
0.10
150
100
0.05
50
0.00
0
0
400
800
1200
1600
2000
2400
2
4
6
8
10
12
14
-50
Output - y
Input - x
1
28
Average and marginal costs
1. When marginal cost is below the average cost,
the average cost curve is falling
2. When the marginal and average costs are
equal, the average cost curve does not
change (is at minimum point)
3. When the marginal cost is greater
than average cost, average cost is rising
4. The marginal cost curve will intersect
AVC and ATC at their minimum points
29
Average and Marginal Cost Curves
0.3
Cost
0.2
0.1
0.0
0
400
800
1200
1600
2000
2400
Output - y
30
Cost curves for alternative function
500
450
Cost
400
350
300
250
200
150
100
50
0
0
10
20
30
40
Output - y
31
Average and Marginal Cost Curves
40
36
Cost
32
28
24
20
16
12
8
4
0
0
10
20
30
Output - y
32
The End