Outcomes

Define the isocost line.

Discuss, calculate and illustrate the slope of the isocost line.
Discuss, calculate and illustrate how the optimal output id determined
given a certain expenditure.
Discuss, calculate and illustrate how costs will be minimized given a
certain level of output.
Discuss and illustrate the effect of mimimum wages by using isoquant
and isocost curves.
Explain and illustrate the relationship between economies of scale and
the LAC, LMA and LTC curves.
Expalin why the LRATC has an envelope shape.
Explain the meaning of the mimimum efficient scale.
Explain the relationship between and the importance of the MES and the number of
firms in the industry.

Illustrate and discuss the reasons for the learning curve.

Costs In The Short Run

Fixed cost (FC): cost that does not vary with the
level of output in the short run (the cost of all
fixed factors of production).
Variable cost (VC): cost that varies with the
level of output in the short run (the cost of all
variable factors of production).
Total cost (TC): all costs of production: the sum
of variable cost and fixed cost.

Costs in the Long Run

Every firm wants to produce a given level of outputs at
the lowest possible costs.
Which combination of inputs must the producer choose in order
to minimise costs?
Depends on the relative cost of capital and labour.

Isocost line: different input combinations each of which

costs the same

Slope of isocost

=
=

negative price relationship

w/r

Figure 8.10: The Isocost Line

Maximum Output
Optimal output, given limited costs, is
reached at the point where the isocost line is
tangent to the highest possible isoquant.
MKTS = MPL / MPK = w/r

Figure 8.11: The Maximum Output

for a Given Expenditure

Figure 8.12: The Minimum Cost

for a Given Level of Output

The Relationship Between Optimal Input Choice

And Long-run Costs
Constant economies of scale - long-run total costs are thus
exactly proportional to output.

LTC is a straight line

LMC and LAC are constant (horizontal) and equal to each other

Diseconomies of scale - a given proportional increase in

output requires a greater proportional increase in all inputs
and hence a greater proportional increase in costs.
A certain % increase in all inputs lead to a smaller % increase in outputs
LTC increases at an increasing rate due to the fact that addisional units of production
are more expensive to produce
LMC and LAC have positive slopes and LMC is on top of the LAC

Increasing economies of scale - long-run total cost rises

less than in proportion to increases in output.
A certain % increase in all inputs lead to a bigger % increase in outputs
LTC increases at a decreasing rate due to the fact that addisional units of production
are cheaper to produce
LMC and LAC have negative slopes and LMC is below the LAC

Fig 8.16: LTC, LMC and LAC curves

with constant returns to scale

Fig 8.17: LTC, LMC, and LAC with

decreasing returns scale

Fig 8.18: LTC, LMC and LAC with

increasing returns to scale

Long run costs and MES

Long run = all costs are variable ( no fixed costs)
LRATC curve has an envelope shape (points of short run curves )
Why?
Indicate lowest possible cost at which firm can produce output = MES
(MINIMUM EFFICIENT SCALE )
MES: the level of production that is required for the LAC to reach
its minimum level.

MES large few firms in the industry

MES small many firms in the industry
Fig. 10.1 on p. 298

Fig. 8.22: U-shaped LAC

Learning curve
A firms MC and ATC may decline due to:
1. Workers became familiar with tasks.
2. Managers learn by their mistakes.
3. Better product design, product design..
4. Lower prices of materials used (suppliers
become more efficient).

Fig 8.24; Economies of scale versus

learning effect