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q1
q0
q00
l per period
1
w
lv
R
T
S
l
k
l
k
l
1/
10
C
(
v
,
w
q
)
avergcostA
C
(v,w
q)
12
C
(
v
,
w
q
)
m
arginlcostM
C
(v,w
q)
Marginal Cost Function
13
Graphical Analysis of
Total Costs
Suppose that k1 units of capital and l1 units
of labor input are required to produce one
unit of output
C(q=1) = vk1 + wl1
14
Graphical Analysis of
Total
Costs
With constant returns to scale, total
Total
costs
costs
are proportional to output
AC = MC
Both AC and
MC will be
constant
Output
15
Graphical Analysis of
Total Costs
Suppose instead that total costs start
out as concave and then becomes
convex as output increases
one possible explanation for this is that
there is a third factor of production that is
fixed as capital and labor usage expands
total costs begin rising rapidly after
diminishing returns set in
16
Graphical Analysis of
Total Costs
Total
costs
Average
and
marginal
costs
Graphical Analysis of
Total Costs
MC is the slope of the C curve
MC
AC
min AC
If MC < AC,
AC must be
falling
If MC >AC,
AC must be
rising
Output
18
v
w
C
(w
,vq)ab
Production will occur at the vertex of the Lshaped isoquants (q = ak = bl and k*/l*=a/b)
C(w,v,q) = vk + wl = v(q/a) + w(q/b)
19
k
kv
lw
v
20
lkq
q
v
w
w
v
1/1
/
/
/
21
C
(v,w
q)B
vk(
w
l)qB
vw
1
//
//
/
where
22
/
1)()/
C
(v,w
qC
)(,vk)w
lq1/(v/1w
Some Illustrative Cost
Functions
23
25
Costs
Cpseudo
C(v,w,q1)
C(v,w1,q1)
27
28
kl w
v
Input Substitution
29
(sw
k/vl)w
/kvln(w
k/vl)
Input Substitution
31
Technical Progress
Improvements in technology also reduce
cost for each level output
Suppose that total costs (with constant
returns to scale) without technical change
are
C0 = C0(q,v,w) = qC0(v,w,1)
33
Technical Progress
After technical change the same inputs that
produced one unit of output in period zero will
produce A(t) units in period t
Ct(v,w,A(t)) = A(t)Ct(v,w,1)
Ct(v,w,1) = C0(v,w,1)/A(t)
=
34
C
(v,w
qC
)vB
,w
vkq(
w
lvk)qw
vl2qvw
B
w
1
//
//
/
0.5
35
C
(3,12q)3612q
36
C
(3,27q)281q
37
38
40
v
w
C
(w
,vq)ab
q (l , k ) min{ al , bk}
41
C
(
v
,
w
q
)
kl(v,w
q)b
a
cc
42
C
(v,w
q)vkw
lqB
vw
1/
//
43
k(v,w
q)
q
B
v
w
vq
B
w
c 1/
/
1
44
l(v,w
q)w
q
B
v
w
w
c 1/
/
1
45
Short-Run, Long-Run
Distinction
In the short run, economic actors have
only limited flexibility in their choice
Assume that the capital input is held
constant at k1 and the firm is free to
vary only its labor input
The production function becomes
q = f(k1,l)
46
k1
q2
q1
q0
l1
l2
l3
l per period
49
Total
costs
SC (k1)
C
The long-run
C curve can
be derived by
varying the
level of k
SC (k0)
q0
q1
q2
Output
51
Costs
SMC (k0)
SAC (k0)
AC
SMC (k1)
q0
q1
SAC (k1)
The geometric
relationship
between shortrun and long-run
AC and MC can
also be shown
Output
52
AC = MC = SAC = SMC
53
56
57
58