Economics Chapter 7 - Cost Concepts

Chapter 7 - Cost Concepts

• Cost concepts cover the relationship between costs and output in short-run and long-run scenarios.
• Short-run and long-run cost curves, and numerical problems are central to understanding cost.
• Long-run average cost analysis is essential, along with learning curves.

Concepts of Cost

• Firms maximize profit by focusing on revenues and costs.
• Profit can be increased by either increasing revenue or reducing cost.
• Market forces generally dictate revenue, while cost reduction can be influenced by factors like production efficiency and output optimization.
• Cost analysis helps businesses decide prices and production decisions.

Private and Social Cost

• Private cost are incurred directly by the producer or firm for the good or service.
• Social cost is incurred by the society due to commodity production, often beyond the producer's direct costs.

Historical and Replacement Cost

• Historical cost is the original purchase price of an asset.
• Replacement cost is the current cost to replace that same asset.

Fixed and Variable Cost

• Fixed costs are expenses that don't change with output levels (e.g., rent).
• Variable costs do change with output levels (e.g., raw materials).

Total, Average, and Marginal Cost

• Total cost (TC) is the sum of all costs.
• Average cost (AC) is per-unit total cost.
• Marginal cost (MC) is the increase in total cost when producing one more unit.

Sunk Cost and Incremental Cost

• Sunk costs are those already incurred and cannot be recovered.
• Incremental costs represent the changes in costs due to decisions.

Cost and Output Relationship (Short-Run)

• Total fixed cost (TFC) remains constant regardless of output levels.
• Total variable cost (TVC) rises with increasing output levels.

Cost and Output Relationship (Long-Run)

• Total cost (TC) is sum of TVC and TFC.

Average Cost and Marginal Cost Relationship

• When MC is below AC, AC falls
• When MC is above AC, AC rises
• When MC equals AC, AC is at its minimum.

Derivation of Long-Run Average Cost Curve

• Long-run average cost (LAC) represents the lowest possible average cost for producing a given output level.

Learning Curve Effect

• Learning curve shows an inverse relationship between average cost of production and the level of output.
• As output increases, the average cost of production declines as a result of experience.
• Learning and experience leads to improved production techniques.

Calculation of Various Costs: Examples

• Detailed examples (Q7 and Q8) of calculating total cost (TC), average cost (AC), average fixed cost (AFC), average variable cost (AVC), and marginal cost (MC).

Short-run vs. Long-run Cost Curves

• Differentiate between short-run and long-run cost curves based on fixed versus variable costs and time horizons.