Comprehensive Study Notes on Cost Curves and Economic Decisions
Cost Curves and Their Shapes
Marginal Cost (MC)
Resembles a Nike swoosh shape.
Is labeled in a graph for clear understanding of curves.
Average Total Cost (ATC)
Is described as resembling a large U shape or bowl.
The minimum point on the ATC curve is found where it intersects with the marginal cost curve.
Average Variable Cost (AVC)
Appears almost parallel to the ATC curve.
It is essential to indicate the minimum point of the AVC where it is processed correctly, illustrating the cost relationships clearly.
Changes in Cost Curves
Forces Affecting Costs:
Factors that lead to an increase in costs include:
Taxes: Directly affect the cost structure.
Input Costs: Increases in the cost of raw materials or labor can lead to higher expenses.
Effects on Cost Curves:
If costs rise:
Both the marginal cost and average total cost curves will shift upward in a parallel manner.
Such shifts signify a decrease in the supply of goods since a higher cost typically leads to fewer products being supplied at previous price levels.
Example: Rising minimum wage increases labor costs, shifting supply curves upward and decreasing supply.
Factors That Decrease Costs:
Advancements like new technology can result in reduced operational costs.
Example: Amazon's usage of advanced robotics in packaging warehouses can streamline processes and lower costs.
Decreases in input costs can also lower overall production costs.
Long Run Production Costs
Definition of Long Run:
Refers to a time frame where all costs are variable, meaning no fixed inputs or costs exist.
In the long run, firms can adjust the scale of their operations, such as increasing or decreasing factory size.
Objective in the Long Run:
The goal is efficiency in production. Companies aim to minimize costs by selecting the optimal factory size and production method.
Envelope Theorem:
Represents the concept in economics used to describe the relationship between short-run cost curves and the long-run average total cost curve.
While operating with one fixed factor in the short run, firms are limited to a specific average total cost curve determined by current production capacity.
In the long run, firms can choose to operate at the most efficient curve based on the number of factories they decide to utilize.
Decision Making in the Long Run
Factory Decisions:
Firms can choose to operate on variety of average total cost curves depending on the scale of production they decide upon.
If the chosen quantity leads to a cost that overlaps with a more efficient curve, firms will opt for the lower-cost setup.
Long Run Average Total Cost Curve (LRATC):
The LRATC is typically wider than average short-run curves as it reflects the most cost-effective points from various short-run scenarios.
Firms should aim to operate at the lowest cost points on the LRATC curve to ensure long-term sustainability and success.
Economies of Scale and Production Costs
Three Sections of Long Run Average Total Cost Curve:
Economies of Scale:
Occurs as output increases; average total costs decrease.
Results from specialization and operational efficiencies.
Example: General Electric's dominance in jet engine production due to cost efficiencies defined by larger production scales.
Constant Returns to Scale:
When average total costs remain relatively stable as output increases.
Balancing effects of increased costs and production efficiencies.
Diseconomies of Scale:
A point where further increases in output lead to rising average total costs.
Caused by complexity in management and potential communication issues as businesses grow.
Sunk Costs and Their Impact on Decision Making
Definition:
Sunk costs are costs that have already been incurred and cannot be recovered.
Economic theory posits that decisions should disregard sunk costs.
Sunk Cost Fallacy:
The tendency to continue an endeavor after failing because of already invested resources (time or money).
Example: Choosing to stay in a bad movie or job because money or time was already spent, leading to suboptimal future decisions.
Real-World Applications:
Many students hesitate to switch majors because of previously completed coursework, erroneously thinking they must follow through with their initial choice.
Economies of Scope
Definition: This refers to a situation where companies reduce average total costs through the production of a variety of products using similar inputs.
Example: General Motors creating multiple car types in a single factory, or Tesla utilizing the same AI technology across various vehicle models.