Lecture 9: Costs - leahbrooks.org...Lecture 9: Costs October 29, 2019. AdminPolicymakersOpp. CostsSunk CostsCost CurvesAC and MCSR and LREconomies ... Input costs drive rm behavior

Admin Policymakers Opp. Costs Sunk Costs Cost Curves AC and MC SR and LR Economies

Lecture 9:Costs

October 29, 2019


Overview

Course Administration

Why Policymakers Should Care About Costs

Accounting vs. Opportunity Costs

Sunk Costs

Cost Curves

Average and Marginal Costs

Short-Run and Long-Run Costs

Economies of Scale and Maybe Scope


Course Administration

1. Problem set 8 posted

2. Midterms return at end of class

3. Elasticity memo• Drafts should be posted• Comments due Sunday November 3, midnight• Feel free to schedule discussion time with your group• Memo due November 19 (Lecture 12)

4. Final exam• December 13, 5:20 to 7:20, Bell 108• Review: Sunday December 8, 1 to 3 pm, Duques 152

5. Any questions?


Ripped from the Headlines

Afternoon

Finder Presenter

Roger Johnson Meschelle Thatcher

Evening

Finder Presenter

Brendan Philip Shaun StevensonMatt Rosenberg Juan Romero-Casillas

Rachel Wein


Costs and Policymakers


Why Should Policymakers Care About Firm Costs?

• Supply costs determine economies of scale

• Input costs drive firm behavior

• Government policy can modify input costs

• Government is frequently a producer itself• how many fighter aircraft do we need to provide defense?• to sign up clients for the Affordable Care Act, which is better:

an improved website, or more personal help?• are the fixed costs of a new data tracking system worthwhile?


Economic Costs vs. Accounting Costs


Economic Costs vs. Accounting Costs

• Accounting cost ≡ direct cost

• Opportunity cost ≡ cost of what you give up by using aninput

• Perhaps most easily thought of as next best opportunity forfunds

• What’s the opportunity cost of pursuing a MPP?• Give an opportunity cost example

Economic cost ≡ accounting cost + opportunity cost


Sunk Costs


Defining Sunk Costs

• Firm has some fixed costs

• If the firm went bankrupt, some of those costs could berecovered

• The non-recoverable part of the fixed costs is called “sunk” –or sunk costs

• Examples?


Now that the Costs are Sunk

• When costs are sunk, they should not enter into futurebusiness decisions

• Making decisions based on sunk costs is known as the “sunkcost fallacy”

• Decisions should be forward-looking: sunk costs are gone


Waterworld and Sunk CostsOr Iraq/Afghanistan Invasion and Sunk Costs, If You Prefer

Costs Ex. Profit

Mo. Ex. Rev. Total Sunk Addt’l Continue No Prod.

June 150 -100 -16 -84 50 -16

Sept. 150 -140 -100 -40 10 -100Dec. 150 -175 -140 -25 -25 -140

• June: Ex. Profit > 0, clearly should go ahead.

• Sept.: Ex. Profit still > 0.

• Dec.: Ex. Profit < 0. Halt production? No,because alternative is loss of 140.a

aTwo good listens on this topics are a Freakonomics podcast and a PlanetMoney transcript/podcast.

http://freakonomics.com/2011/09/30/new-freakonomics-radio-podcast-the-upside-of-quitting/

http://www.npr.org/2015/02/13/385948508/how-sunk-cost-fallacy-applies-to-love



Costs Ex. Profit


June 150 -100 -16 -84 50 -16

Sept. 150 -140 -100 -40 10 -100Dec. 150 -175 -140 -25 -25 -140









Costs Ex. Profit


June 150 -100 -16 -84 50 -16Sept. 150 -140 -100 -40 10 -100

Dec. 150 -175 -140 -25 -25 -140









Costs Ex. Profit


June 150 -100 -16 -84 50 -16Sept. 150 -140 -100 -40 10 -100

Dec. 150 -175 -140 -25 -25 -140









Costs Ex. Profit


June 150 -100 -16 -84 50 -16Sept. 150 -140 -100 -40 10 -100Dec. 150 -175 -140 -25 -25 -140









Costs Ex. Profit


June 150 -100 -16 -84 50 -16Sept. 150 -140 -100 -40 10 -100Dec. 150 -175 -140 -25 -25 -140








Fixed & Variable Costs

Cost Curves


Types of Cost

• Fixed costs ≡ costs that do not depend on how much outputthe firm produces

• Variable costs ≡ costs that do vary with the firm’s output


What Determines Whether the Cost is Fixed or Variable?

Time Horizon

• Many things are fixed in the short run

• Nothing is fixed in the long run

Other Factors

• Active rental markets can turn fixed costs into variable costs

• Long-run labor contracts can make labor a fixed, rather thanvariable cost


What Determines Whether the Cost is Fixed or Variable?

Time Horizon

• Many things are fixed in the short run

• Nothing is fixed in the long run

Other Factors

• Active rental markets can turn fixed costs into variable costs

• Long-run labor contracts can make labor a fixed, rather thanvariable cost


3 Key Cost Curves

• Total cost – recall the expansion path!

• Fixed cost

• Variable cost

We know that TC = FC + VC .

Sketch them on the paper in front of you, starting with FC andVC .


3 Key Cost Curves

• Total cost – recall the expansion path!

• Fixed cost

• Variable cost

We know that TC = FC + VC .Sketch them on the paper in front of you, starting with FC andVC .


Drawing TC, FC and VCWhat Does the Total Cost Curve Look Like?

$

Q


Drawing TC, FC and VCWhat About the Variable Cost Curve?

TC$

Q


Drawing TC, FC and VCAnd the Fixed Cost Curve?

TC$

Q

VC


Drawing TC, FC and VCEveryone, Together

TC$

Q

VC

FC


Average & Marginal Costs


Average Costs

Definitions

• Average total costs: ATC = TCQ

• Average fixed costs: AFC = FCQ

• Average variable costs: AVC = VCQ

What about the shapes?

• AFC

• AVC – remember the law of diminishing returns

• ATC

Note that because there are fixed costs, this must be the short run.


Average Costs

Definitions





• AFC


• ATC



Average Costs

Definitions





• AFC


• ATC



Average Costs

Definitions





• AFC


• ATC



Average Costs in PicturesWhat Does Average Fixed Cost Look Like?

$

Quantity


Average Costs in PicturesWhat About Average Variable Costs?

$

Quantity

AFC


Average Costs in PicturesAnd Average Total Cost?

$

Quantity

AVC

AFC


Average Costs in PicturesEveryone, Together

$

Quantity

ATC

AVC

AFC


Marginal Cost

• Marginal cost ≡ additional cost of producing an additionalunit of output

• Without calculus, MC = ∆C∆Q , or the slope of the total cost

curve

• With calculus, MC = ∂C∂Q

• What is its shape?


Drawing Marginal Cost

$

Quantity

MC


Average vs. Marginal Cost

ATC =C

Q,

MC =∆C

∆Q=

(∂C

∂Q

)

• Both come from total cost

• When MC < ATC , what happens to average cost as Qincreases?

decreases

• When MC > ATC , what happens to average cost as Qincreases? increases

• → MC = AC → AC must be at a minimum

• → MC curve intersects AC curve at minimum



ATC =C

Q,

MC =∆C

∆Q=

(∂C

∂Q

)


• When MC < ATC , what happens to average cost as Qincreases? decreases

• When MC > ATC , what happens to average cost as Qincreases?

increases





ATC =C

Q,

MC =∆C

∆Q=

(∂C

∂Q

)


• When MC < ATC , what happens to average cost as Qincreases? decreases

• When MC > ATC , what happens to average cost as Qincreases? increases




Average and Marginal Costs

$

Quantity

MC

ATC

AVC


Short Run & Long Run Costs


Three Types of Costs

Compare the long and short run for

• Total Costs

• Average Costs

• Marginal Costs


Short Run and Long Run Expansion Paths

• Goal is to consider long-run expansion path

• Then short run expansion path

• Which factor – K or L – is generally fixed in the short run?

• What must be true about the cost of the optimal mix of Kand L in the short run relative to the long run?

• Short run is never less costly than long run


Short Run and Long Run Expansion Paths

• Goal is to consider long-run expansion path

• Then short run expansion path

• Which factor – K or L – is generally fixed in the short run?

• What must be true about the cost of the optimal mix of Kand L in the short run relative to the long run?

• Short run is never less costly than long run


Optimal Input Choices in the Short and Long RunFirm’s Isoquants. What (K , L) Does It Use to Produce?

L

K

Q= aQ= b

Q= c


Optimal Input Choices in the Short and Long RunWith Isocost Curves

L

K

Q= aQ= b

Q= c


Optimal Input Choices in the Short and Long RunLong-Run Optimal Choices and an Expansion Path. What’s Fixed in the Short Run?

L

K

Q= aQ= b

Q= c


Optimal Input Choices in the Short and Long RunK Fixed. What are the optimal (K , L)?

L

K

K is fixed


Optimal Input Choices in the Short and Long RunSR Optimal Bundles: Where are Isocosts?

L

K

K is fixedShort run expansion path


Optimal Input Choices in the Short and Long RunTotal Costs Higher in Short Run

L

K



Optimal Input Choices in the Short and Long RunCompare Long and Short Run Expansion Paths

L

K


K not fixedLong run expansion path


Two Cost Curves: Which One is the Short-Run Curve?What Do You Think?

$

Q


Two Cost Curves: Which One is the Short-Run Curve?Short Run Costs Are Always ≥ Long Run Costs

TCLR

$

Q

TCSR


Short-Run vs Long-Run Average Total Costs

• Repeat the exercise we just did for a variety of levels of initialfixed costs

• What will always be true about the short-run total cost curverelative to the long-run total cost curve?

• The short run cost curve is always ≥ the long-run curve

• Recall – what is the shape of the average cost curve?


Drawing Short- and Long-Run Average Total Cost CurvesLR Average Cost Curve. What About SR AC at K = d?

$

Quantity

ATCLR


Drawing Short- and Long-Run Average Total Cost CurvesAt Another K?

$

Quantity

ATCLR

ATCSR, K=d


Drawing Short- and Long-Run Average Total Cost CurvesAnd Another K?

$

Quantity

ATCLR

ATCSR, K=e

ATCSR, K=d


Drawing Short- and Long-Run Average Total Cost CurvesSR Cost Curves in Envelope of LR Curve

$

Quantity

ATCLR

ATCSR, K=e

ATCSR, K=d ATCSR,

K=f


Short Run vs. Long Run Marginal Costs

• Where does the long-run marginal cost curve intersect theaverage cost curve?

• This holds true for the short-run curves, too


Short Run vs. Long Run Marginal Costs

• Where does the long-run marginal cost curve intersect theaverage cost curve?

• This holds true for the short-run curves, too


Drawing Short-Run Marginal Cost CurvesWhere is SR MC, K = d?

$

Quantity

ATCLR

ATCSR, K=e

ATCSR, K=d ATCSR,

K=f


Drawing Short-Run Marginal Cost CurvesWhere is SR MC, K = e?

$

Quantity

ATCLR

ATCSR, K=e

ATCSR, K=d ATCSR,

K=f

MCSR, K=d


Drawing Short-Run Marginal Cost CurvesWhere is SR MC, K = f ?

$

Quantity

ATCLR

ATCSR, K=e

ATCSR, K=d ATCSR,

K=f

MCSR, K=d MCSR,

K=e


Drawing Short-Run Marginal Cost CurvesEveryone, Together

$

Quantity

ATCLR

ATCSR, K=e

ATCSR, K=d ATCSR,

K=f

MCSR, K=d

MCSR, K=fMCSR,

K=e


An In-Class Problem: Costs

Suppose a firm’s long-run total cost curve isTC = 10Q2 + 6Q + 60, and long-run marginal cost curve isMC = 20Q + 6.

1. Find an expressions for the firm’s

1.1 fixed cost1.2 variable cost1.3 average total cost1.4 average variable cost

2. Find the output level that minimizes average total cost.

3. Find the output level that minimizes average variable cost.

4. Is it possible for MCSR = 15Q + 6 to be short-run marginalcost?


Economics of Scale

and (maybe) Scope


Economies of Scale

Three types

• Economies of scale ≡• output increases more rapidly than total cost• double total cost, more than double output

• Diseconomies of scale ≡• output increases more slowly than total cost• double total cost, less than double output

• Constant economies of scale ≡• total cost and output increase as same rate• double total cost, double output

You can see these in the shape of the average cost curve.


Economies of Scale

Three types

• Economies of scale ≡• output increases more rapidly than total cost• double total cost, more than double output

• Diseconomies of scale ≡• output increases more slowly than total cost• double total cost, less than double output

• Constant economies of scale ≡• total cost and output increase as same rate• double total cost, double output

You can see these in the shape of the average cost curve.


Economies of Scale vs. Returns to Scale

Returns to scale

• Does increase in inputs increase outputs? By how much?

Economies of Scale

• Does increase in outputs increase cost? By how much?

Therefore

• Increasing returns to scale =⇒ economies of scale

• Economies of scale 6=⇒ returns to scale



Returns to scale


Economies of Scale


Therefore





Returns to scale


Economies of Scale


Therefore




Economies of Scope

• Economies of scope ≡ firm produces multiple outputs morecheaply together than it would each individual output

• Diseconomies of scope ≡ firm produces multiple outputs at ahigher cost than it would if it produced each outputindividually

• Where do they come from?

• From sharing common inputs or knowledge


Economies of Scope

• Economies of scope ≡ firm produces multiple outputs morecheaply together than it would each individual output

• Diseconomies of scope ≡ firm produces multiple outputs at ahigher cost than it would if it produced each outputindividually

• Where do they come from?

• From sharing common inputs or knowledge


Recap of Today

• Opportunity Costs

• Sunk Costs

• Cost Curves: Total Cost = Fixed Cost + Variable Cost

• Average Cost and Marginal Cost

• Short Run and Long Run Costs

• Economies of Scale (and maybe Scope)


Next Class

• Read GLS Chapter 8

• Skip 8.5


Midterm Results Distribution

Score Both Afternoon Evening50-59 4 2 260-69 6 4 1070-79 10 2 880-89 10 2 890-100 9 3 6Mean 76.3 79.3 74.7Std. dev. 13.0 16.0 11.2

Curve yields grades

• 90 to 100 A

• 86 to 90 A-

• 75 to 85 B+

• 69 to 74 B

• 61 to 68 B-

• 52 to 60 C+

• If you are on the border of a letter grade, I round up.

• If you got an A and are willing to volunteer to help a student, sendme an email

• If you got a B or below and would like help from a studentvolunteer, send me an email

Documents

Lecture 9: Costs - leahbrooks.org...Lecture 9: Costs October 29, 2019. AdminPolicymakersOpp. CostsSunk CostsCost CurvesAC and MCSR and LREconomies ... Input costs drive rm behavior