Daniel l. Rubinfeld

242 Part 2 Producers, Consumers, and Competitive Markets
I. Managers, investors, and economists must take into
account the opportunity cost associated with the use of
a firm's resources: the cost associated with the opportunities
forgone when the finn uses its resources in its
next best alternative.
2. A slink cost is an expendihtre that has been made and
cannot be recO\-ered. After it has been incurred, it
should be ignored when making future economic
decisions.
3. In the short run, one or more of the firm's inputs are
fixed, Total cost can be divided into fixed cost and
variable cost A firm's lIlarginal cost is the additional
,-ariable cost associated with each additional unit of
output The avcrage variablc cost is the total variable
cost di,'ided by the number of units of output.
4. In the short run, when not all inputs are variable,
the presence of diminishing returns determines the
shape of the cost cun-es .. In particular, there is an
inverse relationship between the marginal product of a
loan association provides a service to its customers, rather than a physical
product. The
-
output Q measure reported here (and used in other studies) is th
e
tota 1 assets ot each savings and loan association. In general, the larger the asset
base of an association, the higher its profitability. Long-run a\-erage cost LAC is
measured by average operating expense, Output and total operating costs are
measured in htmdreds of millions of dollars. Average operating costs are measured
as a percentage of total assets.
A quadratic long-run average cost function was estimated for the year 1975
yielding the follOWing relationship:
'
LAC = 2,38 - 0,6153Q + 0,0536Q2
The estimated long-run average cost function is U-shaped and reaches its
point of minimum a\'erage cost when the total assets of the savings and loan
reach $574 milliorL 2o (At this point the average operating expenses of the savings
and loan are 0.61 percent of its total assets.) Because almost all sa\-ings and
loans in the region being studied had substantially less than $574 million in
assets, the cost function analysis suggests that an expansion of savings and
loans through either growth or mergers would be valuable,
How appropriate such a policy is cannot be fully evaluated here, ho'wever.
To do so, we would need to take into accotmt the possible social costs associated
with the lessening of competition from growth or mergers, and we would
need to assure ourselves that this particular cost function analysis accurately
estimated the point of minimum average cost.
single variable input and the marginal cost of production,
The average variable cost and average total cost
cun'es are U-shaped. The short-run marginal cost
curve increases beyond a certain point, and cuts both
average cost curves from below at their minimum
points,
5. In the long run, all inputs to the production process
are variable, As a result, the choice of inputs depends
both on the relative costs of the factors of production
and on the extent to which the firm can substitute
among inputs in its production process. The costminimizing
input choice is made by finding the point
of tangency between the isoquant representing the
level of desired output and an isocost line,
6. The firm's expansion path shows how its costminimizing
input choices vary as the scale or output
of its operation increases .. As a result, the expansion
path pro,'ides useful information rele,'ant for longrun
pla1U1ing decisions ..
20 You can confirm this principle either by graphing the cun'e or by differentiating the a\'erage cost
tunctlOn \\"tth respect to Q. setting it equal to 0, and solving for Q
The long-run average cost C11r,'e is the em-elope of the
7. firm'S short-run a,-erage cost cun-es, and it reflects
the presence or absence of returns to scale. When
there are constant returns to scale and many plant
sizes are possible, the long-run cost CUlTe is horizontal;
the em-elope consists of the points of minimum
short-run a,'erage cost However, when there are
increasing returns to scale initially and then decreasing
returns to scale, the long-nm a,-erage cost cun-e is
u-shaped, and the em'elope does not include all
points of minimum short-run a,-erage cost.
8. A firm enjoys econolllies or scale when it can double its
output at less than twice the cost Correspondingly,
there are diseconomies of scale when a doubling of
output requires more than twice the cost Scale
economies and diseconomies apply e,-en when input
proportions are \-ariable; returns to scale applies only
when input proportions are fixed.
9. When a firm produces t\\-O (or more) outputs, it is
important to note whether there are economics of scope
1. A firm pays its accountant an annual retainer of
S10,OOO. Is this an explicit or an implicit cost
2. The owner of a small retail store does her own
accounting work. How would you measure the
opportunity cost of her work
3. Suppose a chair manufachlrer finds that the marginal
rate of technical substitution of capital for labor in his
production process is substantially greater than the
ratio of the rental rate on machinery to the wage rate
for assembly-line labor. HO\\- should he alter his use
of capital and labor to minimize the cost of production)
4. Why are isocost lines straight lines
5. If the marginal cost of production is increasing, do
you know whether the a,-erage variable cost is increasing
or decreasing Explain,
1. Assume a computer firm's marginal costs of production
are constant at 51000 per computer. However, the
fixed costs of production are equal to 510,000.
a. Calculate the firm's a\-erage ,-ariable cost and
a\-erage total cost curves.
b. If the firm wanted to minimize the a,-erage total
cost of production, would it choose to be very large
or wry small Explain.
7 The Cost of Production
in production. Economies of scope arise when the
firm can produce any combination of the t\\-O outputs
more cheaply than could two independent firms
that each produced a single product The degree of
economies of scope is measured by the percentage
reduction in cost \\-hen one firm produces t\\'O
products relative to the cost of producing them indi­
\-idually.
10. A firm's average cost of production can fall O\'er time
if the firm "learns" how to produce more effecth-ely.
The leamillg elln'c shows how much the input needed
to produce a gh-en output falls as the cumulath-e output
of the firm increases.
11. Cost functions relate the cost of production to the
firm's le,-el of output The hmctions can be measured
in both the short run and the long run by using either
data for firms in an industry at a given time or data
for an industry over time, A number of functional
relationships, including linear, quadratic, and cubic,
can be used to represent cost functions.
6. If the marginal cost of production is greater than the
a,-erage \-ariable cost, do you know whether the a,-erage
,-ariable cost is increasing or decreasing Explain.
7. If a firm's average cost cun-es are U-shaped, why
does its a,-erage variable cost CUlTe achieve its minimum
at a lower le,-el of output than the a,-erage total
cost curve
8. If a finn enjoys increasing rehlrns to scale up to a certain
output level, and then constant returns to scale,
what can you say about the shape of its long-run a,'erage
cost curve
9. How does a change in the price of one input change a
firm's long-run expansion path
10. Distinguish bet\\'een economies of scale and economies
of scope. Why can one be present without the
other
2. If a firm hires a currently unemployed worker, the
opportunity cost of utilizing the worker's sen-ice is
zero Is this true Discuss.
3. a. Suppose a firm must pay an annual franchise fee
or tax, which is a fixed sum, independent of
whether it produces any output. How does this tax
affect the firm's fixed, marginal, and average
costs