Mıcroeconomıc Theory (ENG) — Ünite 5 Soru-Cevap

The value of the best alternative use of any input is the economic cost of that input.

The accounting cost relies on actual expenses, historical costs and depreciation. Whereas the economists’ definition of cost relies on the opportunity cost concept and what that input would be paid in its best alternative use is defined as the cost of any input. The accountants consider current expenditures on labor as labor costs. According to economists, labor services that are undertaken for some hourly wage rate (w) is also what the labor would have earned in an alternative usage. However, two perceptions of cost differ for capital. Accountants calculate capital costs by using the historical price of the machine that is used and try to find out how much of that machine’s initial price can be attributed to current costs over time through a depreciation rule. On the other hand, economists regard the full opportunity cost of the machine that is the loss in benefits that could be attained by utilizing this machine in a different activity.

Costs can be categorized accordingly whether they are fixed or variable with output.

Fixed costs are associated with the fixed inputs in production. These are costs that are not related to the level of output.

The costs that are related with variable inputs and change with output level are called variable costs.

The sum of both fixed and variable costs is total cost (TC). We can write the total cost function of the firm as:

TC = TFC + TVC

where TVC denotes total variable costs and TFC denotes total fixed costs

Sunk costs are expenses that have been made and cannot be retrieved. To make it simple, assume that you have planned to rent an office for a year. As you have to pay the rent even if you do not produce at all, the monthly rent that you will be paying is a fixed cost. What if you aim to renew the office by painting it? In this case, the cost for paint will be a sunk cost but also a fixed cost because the spending that you have made cannot be reclaimed.

A firm utilizes marginal and average costs in order to make decisions on how much to produce. The increase in cost that results from producing one more unit of output is called marginal cost (MC).

The average cost (AC) measures the cost per unit of output. 

Marginal cost (MC) is the change in variable cost that corresponds to a one-unit change in output MC = ΔTVC/Δq
The change in total variable cost is equal to per unit cost of labor w times the
amount of extra labor, ΔL, needed. Since ΔTVC =w ∙ ΔL, we can write the marginal cost equation as follows:

MC =ΔTVC/Δq = w⋅ ΔL/Δq

SMC curve intersects SAC and SAVC curves at their minimum points. When SMC curve is less than SAC curve, the short run average cost curve declines with output and when SMC is greater than the SAC, short-run average cost increases with output.

If capital (K) and labor (L) measure the amounts used in production and the production function of the firm is written as we can demonstrate the problem of minimizing the cost of producing any given level of output q0 as

Minimize wL + rK
Such that f(K,L) = q0

A locus of points that shows the same total cost for different combinations of inputs is called isocost curve.

The firm should choose a point on the q0 isoquant where the MRTS (of l for
k) is equal to the ratio of the inputs’ prices (w/r) for cost minimization.

Expansion path provides information on changing structure of inputs as output increases while holding the prices of these inputs the same.

The first one as the problem of cost minimization for producing a given level of output, the second one as the problem of choosing the greatest possible output for a given cost level.

The long run total cost provides the minimum cost necessary to obtain a given level of output.

If long run average cost is constant across all output levels, this will lead to a linear long run total cost curve. Long run marginal cost associated with this linear LTC curve is constant and equal to long run average cost.

A linear production function (perfect substitute technology), where an input can be easily replaced by the other input, is defined as follows:
q = aK + bL
where a and b are parameters.

The Leontief production function (fixedproportion technology), where there is no
substitution between inputs, is of the form:
q = min(aK, bL)
where min(.) is the minimum function, and yields the minimum of aK or bL, and a and b are the parameters of the production function.

A firm chooses both its inputs and its outputs in order to achieve maximum economic profits given its technology.

The difference between revenues and costs is called economic profits (π) and profits are dependent to the quantity produced.

Economic profits (π) is, π(q) = TR(q) – TC(q) = p(q) . q – C(q)

The objective of a firm is to maximize its profits subject to a technology constraint. The value of q that profits are maximized is found by taking the
derivative of the profit function with respect to output and then equating it to zero;

∂π(q)/∂q =∂TR(q)/∂q −∂TC(q)/∂q = 0

The first-order condition for this maximum is equal to:

∂TR(q)/∂q =∂TC(q)/∂q

Remember that ∂TC(q)/∂q = MC is equal to marginal cost. Similarly, the  resulting change in total revenue that is attributable to one unit increase in output is defined as marginal revenue (MR). Thus, for profit maximization, the firm equates MR to MC (MR=MC).

The additional revenue a firm acquires when it utilizes one extra unit of an input is called the marginal revenue product.