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Ivan Etzo
University of Cagliari
ietzo@unica.it
Dottorato in Scienze Economiche e Aziendali, XXXIII ciclo
2 Long-run costs
Long Average Costs
Long Marginal Costs
Consider the cost function c(w1 , w2 , y ) and let’s consider the factor
prices fixed, so that the cost function is a function of the output
alone, c(y ).
In the short-run there are some costs that are fixed, that is they do
not depend on the output level (e.g. plant size).
Contrarily, the variable costs change when output changes (e.g.
labor).
Accordingly, total short-run costs can be written as the sum of the
variable costs, cv (y ) and the fixed costs, FC :
c(y ) = cv (y ) + FC
The average cost function measures the cost per unit of output
and can be written as follows:
c(y ) cv (y ) FC
AC (y ) = = + = AVC (y ) + AFC (y )
y y y
FC
Let’s consider the AFC (y ) = y :
when y → 0 then AFC (y ) → ∞
when y → ∞ then AFC (y ) → 0
Thus, AFC (y ) is a rectangular hyperbola
Initially the average cost curve decreases because AFC are decreasing.
But as y increases AFC become smaller while AVC 0 increases, thus
eventually AC increases as well
the level of output which minimizes the AC is called minimal
efficient scale.
Ivan Etzo (UNICA) Lecture 4: Cost Functions 8 / 22
Marginal costs
The marginal cost curve measures the change in costs for a given
change in output.
dcv (y ) cv (y + dy ) − cv (y )
MC (y ) = =
dy dy
.
because c(y ) = cv (y ) + FC
What is the relationship between the MC and the AVC curve?
The MC curve must lie below (above) the AVC curve when this one
is decreasing (increasing).
ycv0 (y ) − cv (y ) < 0
cv (y )
cv0 (y ) <
y
This also implies that the MC curve must intersect the AVC at its
minimum point.
Ivan Etzo (UNICA) Lecture 4: Cost Functions 10 / 22
Marginal costs and average cost curves
Important points:
The AVC curve may initially slope down due to increasing average
products of the variable factor for small output levels.
the AC curve will initially slope down due to decreasing average fixed
costs.
The AFC curve can be obtained as a difference between AC curve and
AVC .
The MC and AVC are the same at the first unit of output.
The MC equals both the AC and the AVC at their minimum point.
Ivan Etzo (UNICA) Lecture 4: Cost Functions 11 / 22
Marginal costs and variable costs
Suppose that, in the short-run, the factor 2 is fixed at x̄2 , then the
cost minimization problem is the following:
min w1 x1 + w2 x̄2
x1 ,x2
such that
f (x1 , x2 ) = x1a x̄2b
Thus a
1
c(w1 , w2 , x̄2 ) = y a x̄2b w1 + w2 x̄2
Ivan Etzo (UNICA) Lecture 4: Cost Functions 13 / 22
Cost curves: Examples with the Cobb-Douglas technology
(Short-run)
1 a
The Short-run costs: cs (y , w1 , w2 , x̄2 ) = y a x̄2b w1 + w2 x̄2
1−a a
w2 x̄2
The Short-run Average Costs (SAC): SAC (y ) = y a x̄2b w1 + y
1−a a
The Short-run Average Variable Costs (SAVC): SAVC (y ) = y a x̄2b w1
w2 x̄2
The Short-run Average Fixed Costs (SAFC): SAFC (y ) = y
1−a a
w1
The Short-run Marginal Costs SMC (y ) = y a x̄2b a
In other words, the minimum cost when all factors are variable (i.e.
the long run cost function) is just the minimum cost when factor 2 is
fixed at the level that minimizes the long-run costs.
Ivan Etzo (UNICA) Lecture 4: Cost Functions 15 / 22
Long-run and short-run costs
AC (y ) ≤ ACs (y , x̄2∗ )
When we evaluate this expression for the output level y ∗ and the associated
optimal level of k, that is k ∗ , then we know that :
∂cs (y ∗ , k ∗ )
=0
∂k
In fact, this is the necessary condition for k ∗ to be the optimal level which
minimizes the costs when y = y ∗ . Thus, we are left with:
dc(y ) ∂cs (y , k)
= =⇒ LMC (y ) ≡ SMC (y )
y ∂y
Ivan Etzo (UNICA) Lecture 4: Cost Functions 20 / 22
The Long-run marginal costs