Chapter 21 Varian: Cost Minimisation

Fixed costs

Costs associated with the fixed factors: they are independent of the level of output, and, in particular, they must be paid whether or not the firm produces output Must be paid regardless of what level of output the firm produces

Quasi-fixed costs

Costs that are also independent of the level of output, but only need to be paid if the firm produces a positive amount of output.

Sunk costs

Costs that are not recoverable

Variable costs

Costs which change when output changes

Marginal cost function

Keeps track of how much each additional unit of output costs to produce

Average cost function

The cost per unit to produce y units of output

Unit cost function

When y = 1 (producing 1 unit of output) c ( w1, w2, 1)

Cost function

c(w1, w2, y) Measures the minimum costs of producing a given level of output at given factor prices N.B. for the most part regard factor prices as being fixed so we can write c(y)

Constant returns to scale implies

constant average cost for any y Average cost is constant as y (output) increases

Increasing returns to scale implies:

decreasing average cost with increasing y Average cost decreases as y (output) increases

Decreasing returns to scale implies:

increasing average cost with increasing y Average cost increases as y (output) increases

Conditional/derived factor demands

x1 (w1, w2, y) x2( w1, w2, y) Measure the relationship between the prices and output and the optimal factor choice of the firm, conditional on the firm producing a given level of output, y. The conditional factor demands give the cost-minimising choices for a given level of output. The conditional factor demand functions must slope down.