B.  The Cost of Production

1.  Measuring cost

• Opportunity cost - cost of foregone opportunities

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• Accounting cost - actual expenses plus depreciation charges

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• Economic cost - cost of utilizing economic resources in production, includes opportunity cost

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• Sunk cost - expenditures that have been made and cannot be recovered

- Should not affect decisions

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2.  Short-run costs

• Some inputs are fixed in the short-run

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a.  Total costs

(1) Fixed cost (FC) - costs that do not vary with the level of output

(2) Variable cost (VC) - costs that vary as output varies

(3) Total cost (TC) - total economic cost of production

TC = FC + VC

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b.  Per unit costs

(1)  Marginal cost (MC)

MC = 

(2) Average fixed cost (AFC)

AFC = FC / Q

(3) Average variable cost (AVC)

AVC = VC / Q

(4) Average total cost (ATC)

ATC = TC / Q

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3.  Long-run costs

• All inputs are variable in the long run

a.  Cost minimization

• Minimize the cost of producing a given level of output

(1)  Isocost line - all combinations of capital and labor that can be bought at a given total cost

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(2)  Equilibrium

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(3)  Expansion path

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b. Long-run cost curves

(1)  Inflexibility in the short-run

• Some inputs are fixed

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(2)  Average and marginal cost

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(a)  Economies of scale - average cost decreases as output increases

• Due to:

- Workers specialization

- More flexibility in using inputs

- Can get discounts by buying inputs in bulk

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(b)  Diseconomies of scale - average cost increases as output increases

• Due to:

- Space and equipment make it more difficult for workers to do jobs effectively

- Managing becomes more complex

- Benefits of buying in bulk may disappear

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(3)  Short-run vs. long-run

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4.  Production with two outputs

a.  Product transformation curves

• Some inputs can be used to produce more than one product

• Product transformation curve shows combinations of outputs that can be produced by a given set of inputs

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b.  Economies and diseconomies of scope

(1)  Economies of scope

• Joint output of a single firm is greater than if separate firms produce the items independently

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(2)  Diseconomies of scope

• Joint output of a single firm is less than if separate firms produce the items independently

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c.  Degree of economies of scope

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