Cost Curve - Final Lecture

Review of Cost Curves

Supply Function from Cost Curves

• Axes: Quantity (X-axis), Price (Y-axis or sometimes called Q or Y)
• Average Variable Cost (AVC) Curve:
  • AVC decreases when Marginal Cost (MC) is below AVC.
  • AVC increases when MC is above AVC.
  • At zero level, MC equals AVC.
• Marginal Cost (MC) Curve:
  • Upward sloping part is crucial for determining supply function.
• Supply Function:
  • Quantity supplied (Q) is a function of market price (P).
  • Higher price increases willingness to supply.
  • Important conditions:
    • Upward sloping part of the MC curve above AVC.
    • Firm should avoid production if price is lower than AVC due to inability to recover variable costs.

Short Run vs Long Run Costs

Isocost and Isoquant Lines

• Axes: Labor (L on X-axis), Capital (K on Y-axis).
• Isocost Lines:
  • Represent combinations of capital and labor that cost the same.
  • Formula: rk + wL = C, where r = cost of capital, w = cost of labor.
• Isoquant Lines:
  • Represent combination of L and K yielding the same output Q.
  • E.g., Cobb-Douglas Production Function: Q = K^0.5 * L^0.5.

Cost in Short Run vs Long Run

• Short Run:
  • Capital (K) is fixed.
  • Cost can be higher than long run due to inflexibility.
• Long Run:
  • Both K and L are variable.
  • Can achieve optimal combination of inputs, usually at lower cost.
• Comparative Analysis:
  • At Q1: Short Run Total Cost > Long Run Total Cost.
  • At Q2: Short Run Total Cost = Long Run Total Cost (optimal capital).
  • At Q3: Short Run Total Cost > Long Run Total Cost.

Graphical Analysis

• Total Cost: Linear in the long run due to constant returns to scale.
• Marginal Cost:
  • Determined by cost of additional unit of labor (W/MPL).
  • Higher fixed capital reduces marginal cost, affecting slope of the curve.
• Average Costs:
  • Long Run Average Cost (LRAC) is a flat line for constant returns to scale.
  • Short Run Average Cost (SRAC) varies with fixed capital levels and envelopes LRAC from above.

Further Considerations

• Short vs Long Run Cost Curves:
  • SRAC curves will always envelope LRAC curve from above.
  • Optimal points equate SRAC with LRAC at corresponding output levels but diverge otherwise.
• Marginal Cost in Different Scenarios:
  • With discrete capital levels, each SRAC has its specific MC curve.
  • If capital varies continuously, the LRAC and corresponding MC curves smooth out.

Key Takeaways

• Short run costs are typically higher than long run costs due to fixed capital.
• Understanding cost structures helps in strategic decision-making on production levels.

Conclusion

• Essential to grasp differences between short run and long run cost behaviors.
• Important for firms to focus on upward sloping part of MC and its relationship with AVC for supply decisions.
• Final session on cost curves concludes with key insights on cost behaviors and production strategies.

For any questions or further discussion, refer to the live session. Understanding these concepts is crucial for effective economic analysis and decision-making.

End of Cost Curve Series.