Costs and Factor Inputs
Written by: Edmund Quek
CHAPTER 6 THE THEORY OF COST
LECTURE OUTLINE 1 2 2.1 2.2 2.3 2.4 2.5 2.6 3 3.1 3.2 3.3 INTRODUCTION SHORT-RUN THEORY OF COST Distinction between fixed cost and variable cost Total cost Marginal cost Average cost Relationship between marginal cost and average cost Optimum capacity LONG-RUN THEORY OF COST Cost minimisation in the long run Long-run average cost Productive efficiency
References John Sloman, Economics William A. McEachern, Economics Richard G. Lipsey and K. Alec Chrystal, Positive Economics G. F. Stanlake and Susan Grant, Introductory Economics Michael Parkin, Economics David Begg, Stanley Fischer and Rudiger Dornbusch, Economics
© 2011 Economics Cafe All rights reserved.
Page 1
Written by: Edmund Quek
1
INTRODUCTION
Explicit costs are costs that involve monetary payments such as the costs of materials and labour. Accounting costs include only explicit costs. Implicit costs are costs that do not involve monetary payments such as the costs of the owner’s labour and financial capital. Economic costs include both explicit costs and implicit costs. Economists are concerned with economic profit and hence economic costs. An increase in output will require an increase in the quantity of factor inputs which will lead to an increase in costs. The theory of cost is the study of how the cost of production changes as the output level changes. This chapter gives an exposition of the theory of cost.
2 2.1
SHORT-RUN THEORY OF COST Distinction between fixed costs and variable costs
Fixed costs are costs that do not vary with the output level as they are associated with fixed factor inputs. In other words, an increase in the output level will not lead to an increase in fixed costs. Fixed costs will still be incurred even if the firm shuts down production. Examples of fixed costs are interest payments on loans for the purchase of capital goods (factories and machinery), insurance premiums and rent. Variable
CHAPTER 6 THE THEORY OF COST
LECTURE OUTLINE 1 2 2.1 2.2 2.3 2.4 2.5 2.6 3 3.1 3.2 3.3 INTRODUCTION SHORT-RUN THEORY OF COST Distinction between fixed cost and variable cost Total cost Marginal cost Average cost Relationship between marginal cost and average cost Optimum capacity LONG-RUN THEORY OF COST Cost minimisation in the long run Long-run average cost Productive efficiency
References John Sloman, Economics William A. McEachern, Economics Richard G. Lipsey and K. Alec Chrystal, Positive Economics G. F. Stanlake and Susan Grant, Introductory Economics Michael Parkin, Economics David Begg, Stanley Fischer and Rudiger Dornbusch, Economics
© 2011 Economics Cafe All rights reserved.
Page 1
Written by: Edmund Quek
1
INTRODUCTION
Explicit costs are costs that involve monetary payments such as the costs of materials and labour. Accounting costs include only explicit costs. Implicit costs are costs that do not involve monetary payments such as the costs of the owner’s labour and financial capital. Economic costs include both explicit costs and implicit costs. Economists are concerned with economic profit and hence economic costs. An increase in output will require an increase in the quantity of factor inputs which will lead to an increase in costs. The theory of cost is the study of how the cost of production changes as the output level changes. This chapter gives an exposition of the theory of cost.
2 2.1
SHORT-RUN THEORY OF COST Distinction between fixed costs and variable costs
Fixed costs are costs that do not vary with the output level as they are associated with fixed factor inputs. In other words, an increase in the output level will not lead to an increase in fixed costs. Fixed costs will still be incurred even if the firm shuts down production. Examples of fixed costs are interest payments on loans for the purchase of capital goods (factories and machinery), insurance premiums and rent. Variable