Costs of Production II

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Costs of Production (II)
ECO 105 Lecture 2.5 24 September 2008
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Types of Cost (Review)

• Two major divisions
• Fixed cost - does not vary with quantity of
  output produced
• E.g., rent interest payments
• Variable cost - varies with quantity of output
  produced
• E.g., wages material inputs

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Cost Constructs

• Three average cost measures
• Average Total Cost (ATC) - Total cost divided
• Average Fixed Cost (AFC) - Fixed cost divided
• Average Variable Cost (AVC) - Variable cost

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. . . and the Biggie

• Marginal Cost (MC) - addition to total cost
  arising from the production of one more unit of
  output
• MC DTC/DQ
• (which also equals DTVC/DQ)
• MC is very important to managers making
  production decisions.

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Getting the hang of it . . .

• Use the data on Total Cost and Fixed Cost to fill
  in the table on your handout.

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Those Shapely Cost Curves

• Lets plot the cost curves that correspond to the
  average and marginal costs on your handout.

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All Hallows Een, Co.
MC
ATC
AVC
AFC
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Properties of Cost Curves

• 1. AFC
• FC is spread over
• 2. AVC always lies
• Since TC FC VC, this must be.
• 3. When MC lies below AVC, AVC is _______ when
  MC lies above AVC, AVC is __________. (Ditto for
  ATC).
• MC pulls

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Properties . . .

• 4. MC cuts AVC and ATC at
• This must be the case, because MC pulls AVC and
  ATC
• Efficient scale of output - minimum point on the
• Minimizes

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Stylized Cost Curves
Costs
ATC
MC
AVC
AFC
Output
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Long-Run Production Costs

• Economists define the long run as a period of
  time
• There is ____________________ in the long run.

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What is LRAC?

• The long-run average cost curve (LRAC) is a
• It shows the lowest average cost for different
  quantities when all factors of production

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Example

• An automobile company wants to build a factory to
  produce 150,000 cars per year.
• It must choose among various combinations of
  capital, material inputs, and labor.
• It should choose the combination that

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Economies of Scale

• LRAC falls up to Q Production exhibits
  ______________________.
• Beyond Q LRAC rises ____________
  __________________.
• Some industries have _______________
  ____________________.
• Industries differ by product and technology.

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Technology and Production

• Some production processes are ________ intensive,
  others are _________ intensive.
• Furniture making is
• Computer chip production is
• Technological improvements reduce production
  costs