Supply Curve

1
Supply Curve

• Ch. 6 The theory of cost

2
The definition of cost P. 153

• Cost is defined as
• Cost are not defined as

The highest valued option forgone.
The undesirable, or painful, consequences of some
act. Such consequences will affect its value but
not the cost. (P. 154)
3
What to produce with 1m?
Value2
Value1.5
A swimming pool or a library?
Whats the value of each option?
What will be the choice? Whats the cost?
An option should be chosen if, and only if, its
value gt its cost. (P.153-p2)
4
Choice implies cost (P.153-p3)
The concept of cost and choice be irrelevant,

• Only if no alternatives were possible
• Or if resources were available in amounts
  exceeding everyones desires (e.g. free good)

5
Remarks about cost P. 155

• Only the highest-valued option forgone counts as
  a cost
• Cost will change only if the highest-valued
  option forgone is changed
• No choice, there is no cost
• Time itself is not a cost
• Higher cost ? one is worse off

6
Historical Cost / Sunk Cost P. 156

• It is the original cost at which a firm acquired
  a factor.
• Since past options are not presently available,
  historical cost is not considered as cost.
• It is irrelevant in making decisions.

7
What is the cost for using the following machine?

• Suppose a firm has just purchased a machine for
  10,000.
• It is installed in the firm cannot be leased to
  anyone else.
• Its second-hand value is 5,000.

8
Explicit Implicit/Imputed cost P.158

• Explicit cost costs that involve a transfer of
  funds from a firm to other parties who have
  contributed to output by supplying factors of
  production.e.g. payment for rent
• Imputed cost costs which must be assigned to
  factors of production that the firm neither
  purchases nor hires because it already owns them.
• e.g. cost of operating a self owned premise

9
Implicited / Imputed cost

• The cost of capital
• Market rate of interest
• Special advantages
• Valuable patent
• Highly desirable location
• Popular brand name

10
Actions and Cost P. 159

• Acquisition cost is the amount forgone in
  acquiring the ownership of an asset.
• Acquisition cost original price immediate
  resale value
• Possession cost is the amount forgone in
  keeping an asset without using it.
• Operating cost is the amount forgone in using
  an asset.

11
Application
Types of cost
First registration fee
Annual license fee
Gasoline tax
Insurance
Gasoline, oil etc.
Parking fee
Acquisition cost
Possession cost
Operating cost
Possession cost
Operating cost
Possession cost
12
Production involves factor inputs which can be
divided into fixed variable factors.

• Fixed factors would not vary with output, when
  output increase its remain unchanged.
• E.g. machinery, plant and skilled labour.
• Variable factors change with output, when output
  increase its also increase.

13
Short Run (S-R)

• Is the period over which there is at least one
  factor remains unchanged. Output can be varied
  by adjusting the employment of the variable
  factors, with the fixed factors remain unchanged.
• However, if a variable factor is added
  continuously to a given amount of fixed factors,
  the marginal product ( and the average product )
  of the variable factor will eventually decrease.
  This is called the law of diminishing marginal
  returns.

14
Long Run (L-R)

• Is the period over which all factors are
  variable. Within this period, all factors of
  production have been fully adjusted to the
  optimal output level.

15
Output

• Total Product (TP) is the entire amount of output
  produced by all factors employed.
• Average Product (AP) is the output per unit of
  variable factor employed ( calculated by dividing
  the total product by the number of variable
  factor ).
• Marginal Product (MP) is the change in output
  resulting from employing an additional unit of
  variable factor.

16
Wheat production per year from a particular farm
Number of workers 0 1 2 3 4 5 6 7 8
TP 0 3 10 24 36 40 42 42 40
MP 0 3 7 14 12
AP 0 3 5 7 6
Tonnes of wheat produced per year
Number of farm workers
17
Wheat production per year from a particular farm
TP
Tonnes of wheat produced per year
Number of farm workers
18
Wheat production per year from a particular farm
TP
Diminishing returns set in here
Tonnes of wheat produced per year
b
a
Number of farm workers
19
Wheat production per year from a particular farm
d
TP
Maximum output
Tonnes of wheat produced per year
b
a
Number of farm workers
20
TP
Tonnes of wheat per year
DTP 7
Number of farm workers (L)
DL 1
MP DTP / DL 7
Tonnes of wheat per year
Number of farm workers (L)
21
TP
Tonnes of wheat per year
Number of farm workers (L)
Tonnes of wheat per year
MP
Number of farm workers (L)
MPP
22
TP
Tonnes of wheat per year
Number of farm workers (L)
AP TP / L
Tonnes of wheat per year
AP
Number of farm workers (L)
MPP
23
TP
Tonnes of wheat per year
b
Diminishing returns set in here
Number of farm workers (L)
b
Tonnes of wheat per year
AP
MP
Number of farm workers (L)
MPP
24
d
TP
Maximum output
Tonnes of wheat per year
b
Number of farm workers (L)
b
Tonnes of wheat per year
AP
MP
d
Number of farm workers (L)
MPP
25
d
c
Slope TP / L AP
TP
Tonnes of wheat per year
b
Number of farm workers (L)
b
c
Tonnes of wheat per year
AP
MP
d
Number of farm workers (L)
MPP
26
Production Cost

• Fixed Cost (FC) - is the cost does not change
  with output level. Its can be sub-divided into
  total fixed cost (TFC) and average fixed cost
  (AFC).
• Variable Cost (VC) is the cost that varies with
  output level. Its can be sub-divided into total
  variable cost (TVC), average variable cost (AVC).

27
Production Cost

• Total cost (TC) is the entire amount of
  payments to all factors used in producing a given
  level of output.
• Average Cost (AC) is the cost per unit of
  output. TC/Q
• Marginal Cost (MC) is the change in total cost
  for producing an additional unit of output.

28
Total costs for firm X
Output (Q) 0 1 2 3 4 5 6 7
TVC () 0 10 16 21 28 40 60 91
TFC () 12 12 12 12 12 12 12 12
TVC
TFC
29
Total costs for firm X
Output (Q) 0 1 2 3 4 5 6 7
TVC () 0 10 16 21 28 40 60 91
TC () 12 22 28 33 40 52 72 103
TFC () 12 12 12 12 12 12 12 12
TC
TVC
TFC
30
Total costs for firm X
TC
TVC
Diminishing marginal returns set in here
TFC
31
Marginal cost
MC
Costs ()
x
Output (Q)
32
Average and marginal costs
MC
AVC
Costs ()
y
x
Output (Q)
33
Average and marginal costs
MC
AVC
Costs ()
y
x
AFC
Output (Q)
34
Average and marginal costs
MC
AC
AVC
Costs ()
z
y
x
AFC
Output (Q)
35
Historical cost (Sunk cost)

• Historical cost Cost of acquiring the asset
  its resale value
• Is the past cost of a past act.
• It is not the opportunity cost. Therefore,
  historical cost is not a cost.
• It is irrelevant to any decision making.
• However, if someone cannot acquire any useful
  information, historical cost can be used to
  estimate the present and future costs of an act.

36
Efficiency in Production

• Equalizing marginal costs
• MCa MCb

37
Alchians rate effect and volume effect

• Rate Effect
• Given the volume of output
• If rate of production increases
• AC and MC will also increase

38

• Volume Effect
• Given the rate rate of production
• If the volume of production increase
• AC and MC will decrease
• Reasons Machines can be better used
• Learning by doing

39
Higher rate of production and Larger
volume Increase total costs. Higher rate of
production increase per unit cost (AC). Higher
production volume decrease per unit
cost. Whether AC is falling or rising depends on
the Relative strenght of these two effects.
40
Economics notes past paper collection