Cost of Production

2717 Words11 Pages
Costs of Production

July 2011

Topics to be Discussed
Measuring Cost: Which Costs Matter? How do Cost Curves Behave? – Cost in the Short Run – Cost in the Long Run How to Minimize Cost? How to draw Implications for Business Strategy?

Topics to be Discussed
Production with Two Outputs: Economies of Scope Dynamic Changes in Costs: The Learning Curve Estimating and Predicting Cost

Measuring Cost: Which Costs Matter? Accountants tend to take a retrospective view of firms’ costs, whereas economists tend to take a forward-looking view Accounting Cost – Actual expenses plus depreciation charges for capital equipment Economic Cost – Cost to a firm of utilizing economic resources in production, including opportunity cost

Costs
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HOW does it MOVE? Extent of Rise in Cost Depends on the nature of the PRODUCTION PROCESS – Extent to which production involves DIMINSHING RETURNS to VARIABLE FACTORS If MARGINAL PRODUCT OF LABOUR DECREASES significantly as more labor is hired – Costs of production increase rapidly – Greater and greater expenditures must be made to produce more output

Determinants of Short Run Costs
Assume Labour: only Variable Input Assume the wage rate (w) is fixed relative to the number of workers hired Variable costs is the per unit cost of extra labor times the amount of extra labor: wL

∆VC w∆L MC = = ∆Q ∆Q

A Firm’s Short Run Costs
Inference: MC decreases initially with increasing returns (0 through 4 units of output) MC increases with decreasing returns (5 through 11 units of output)

TC
Cost 400
($ per year)

300

Total cost is the vertical sum of FC and VC.

VC

200

Variable cost increases with production and the rate varies with increasing and decreasing returns.

100
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