unit 2.2 2016 students [compatibility mode].pdf

8/17/2019 Unit 2.2 2016 students [Compatibility Mode].pdf

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Outcomes

• Define the isocost line.

• Discuss, calculate and illustrate the slope of the isocost line.

• Discuss, calculate and illustrate how the optimal output id determinedgiven a certain expenditure.

• Discuss, calculate and illustrate how costs will be minimized given acertain level of output.

• Discuss and illustrate the effect of mimimum wages by using isoquantand isocost curves.

• Explain and illustrate the relationship between economies of scale andthe LAC, LMA and LTC curves.

• Expalin why the LRATC has an envelope shape. – Explain the meaning of the mimimum efficient scale .

– Explain the relationship between and the importance of the MES and the number offirms in the industry.

• Illustrate and discuss the reasons for the learning curve.


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Costs In The Short Run• Fixed cost (FC): cost that does not vary with the

level of output in the short run (the cost of allfixed factors of production).

• Variable cost (VC): cost that varies with the

level of output in the short run (the cost of allvariable factors of production).

• Total cost (TC): all costs of production: the sumof variable cost and fixed cost.


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Costs in the Long Run

• Every firm wants to produce a given level of outputs atthe lowest possible costs.

– Which combination of inputs must the producer choose in orderto minimise costs?• Depends on the relative cost of capital and labour.

• Isocost line: different input combinations each of whichcosts the same

Slope of isocost = negative price relationship= – w/r


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Figure 8.10: The Isocost Line


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Maximum Output

Optimal output, given limited costs, isreached at the point where the isocost line is

tangent to the highest possible isoquant.

MKTS = MPL / MPK = w/r


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Figure 8.11: The Maximum Output

for a Given Expenditure


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Figure 8.12: The Minimum Cost

for a Given Level of Output


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The Relationship Between Optimal Input Choice

And Long-run Costs

• Constant economies of scale - long-run total costs are thusexactly proportional to output.

- LTC is a straight line – LMC and LAC are constant (horizontal) and equal to each other

• Diseconomies of scale - a given proportional increase inoutput requires a greater proportional increase in all inputsand hence a greater proportional increase in costs. – A certain % increase in all inputs lead to a smaller % increase in outputs

– LTC increases at an increasing rate – due to the fact that addisional units of productionare more expensive to produce

– LMC and LAC have positive slopes and LMC is on top of the LAC

• Increasing economies of scale - long-run total cost risesless than in proportion to increases in output. – A certain % increase in all inputs lead to a bigger % increase in outputs

– LTC increases at a decreasing rate – due to the fact that addisional units of productionare cheaper to produce

– LMC and LAC have negative slopes and LMC is below the LAC


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Fig 8.16: LTC, LMC and LAC curves

with constant returns to scale


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Fig 8.17: LTC, LMC, and LAC with

decreasing returns scale


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Fig 8.18: LTC, LMC and LAC with

increasing returns to scale


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Long run costs and MES

• Long run = all costs are variable ( no fixed costs)

• LRATC curve has an envelope shape (points of short run curves ) – Why?

• Indicate lowest possible cost at which firm can produce output = MES(MINIMUM EFFICIENT SCALE ) – MES : the level of production that is required for the LAC to reach

its minimum level.

• MES large – few firms in the industry• MES small – many firms in the industry

Fig. 10.1 on p. 298


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Fig. 8.22: U-shaped LAC


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Learning curveA firm’s MC and ATC may decline due to:

1. Workers became familiar with tasks.

2. Managers learn by their mistakes.

3. Better – product design, product design..4. Lower prices of materials used (suppliers

become more efficient).


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Fig 8.24; Economies of scale versus

learning effect

unit 2.2 2016 students [compatibility mode].pdf

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