Chapter 8

Cost Curves
Definition: The long run total cost function relates minimized total cost to output,
Q, and to the factor prices (w and r).
TC(Q,w,r) = wL*(Q,w,r) + rK*(Q,w,r)
Where: L* and K* are the long run input demand functions

The expansion path enables

construction of a LR cost curve that
relates output to
the least cost way of producing each
level of output.

What Happens When Just one input Price Change?

Chapter 8

What Happens When All Input Prices Change Proportionately?

Average & Marginal Cost Curves

Definition: The long run average cost function
is the long run total cost
function divided by output, Q.
That is, the LRAC function tells us the firms cost per unit of output

Definition: The long run marginal cost function measures the rate of change of
total cost as output varies, holding constant input prices.

What is Their Relationship

Chapter 8

Definition: If LRAC decreases as output rises, all else equal, the cost function
exhibits economies of scale.
Similarly, if LRAC increases as output rises, all else equal, the cost function
exhibits diseconomies of scale.
Definition: The smallest quantity at which LRAC curve attains its minimum point
is called the minimum efficient scale.
When the production function exhibits increasing returns to scale, the long run
average cost function exhibits economies of scale so that AC(Q) decreases with Q,
all else equal.

When the production function exhibits decreasing returns to scale, the long run
average cost function exhibits diseconomies of scale so that AC(Q) increases with
Q, all else equal.
When the production function exhibits constant returns to scale, the long run
average cost function is flat: it neither increases nor decreases with output.
Output Elasticity of Total Cost
Definition: The percentage change in total cost per one percent change in output is
the output elasticity of total cost, TC,Q.
TC,Q = (TC/TC)(Q /Q) = (TC/Q)/(TC/Q) = MC/AC
If TC,Q < 1, MC < AC, so AC must be decreasing in Q. Therefore, we have
economies of scale.
If TC,Q > 1, MC > AC, so AC must be increasing in Q. Therefore, we have
diseconomies of scale.
If TC,Q = 1, MC = AC, so AC is just flat with respect to Q.

Chapter 8

Short Run Costs

The short-run production function, i.e. the total product function determines
the shape of a firms cost curves.
What are short-run costs?
Total Variable Costs the sum of total expenditures on variable inputs, such as
labor and materials, at the short-run cost-minimizing input combination
Total Fixed Costs the cost of fixed inputs; it does not vary with output
STC = TVC + TFC
Marginal cost (MC): the amount by which a firms cost changes if it
produces one more unit of output.
Average fixed cost (AFC): FC divided by output produced
Average variable cost (AVC): VC divided by output produced
Average cost (AC): C divided by output produced
Recall from ch 6 that diminishing MP occurs after a point as more L is hired (point
A). How does this affect MC =
? To increase output firm must hire more L
(K is fixed), if MPL decreases as L increases, successively greater expenditures
must be made to produce more output.

Chapter 8

The Shapes of Short-run Cost Curves

A -MPL sets in, SMC starts to ,
TVC starts to at an rate.
B-the ray from the origin is tangent to
TVC, AVC = SMC, AVC is at min.
Also, AVC = TVC /Q = wL/Q =
w/APL.

Then we can draw TFC, and SRTC.

Notice dSRTC/dQ = dTVC/dQ +
dTFC/dQ = dTVC/dQ, slopt of SRTC
and TVC are the same everywhere.
Then we can draw SATC from
SATC = SRTC /Q or SATC = AFC +
AVC

Chapter 8

Long Run Average Cost Function

LRAC curve forms a boundary around the set of SRAC curves corresponding to
different levels
Suppose only 3 plant sizes are possible. Say the firm had the plant size 1. And it
wants to produce Q0 units of output. The minimum cost of producing Q0 units of
output in the short-run is
. But in the long-run if the firm changes its plant size
to 2, it can produce that quantity at a lower cost of

When they are many plant sizes available, LRAC is smooth and U-shaped.

Notice:
If Q = 1million, and firm had
K = 1, STRC = LRTC. Then, AMC =
LRMC
SRAC does not necessarily
reach its minimum point where
SRAC = LRAC like points C
and D. But at B, min LRAC =
min SRAC = SMC = LRMC.

Chapter 8