Properties of cost functions

These examples illustrate some properties of total cost functions that are quite general.
1. Homogencity. The totalcost functions in Example 10.3 are all homogencous ofdegree 1
in the input prices. That is, a doutbling of input prices will precisely doubie the cost of
producing any given output level (you might check this out for yourself). This is a
property of allproper cost functions. When all input prices double (or are increased by
any uniform proportion), the ratio of any two input prices wil not change. Because
cost minimization requires that the ratio of input prices be set equal to the RTS along a
given isoquant, the cost-minimizing input combination also will not change. Hence,
the firm will buy exactly the same set ofinputs and pay precisely twice as much for them.
One implication of this result is that a pure, uniform inflation in all input costs will not
change a firm's input decisions. Its cost curves will shift upward in precise correspon
dence to the rate of inflation.
2 Total cost functions are nondecreasing in q, v, and w. This property seems obvious,
but it is worth dwelling on it a bit. Because cost functions are derived from a cost
minimization process, any decline in costs from an increase in one of the function's
arguments would lead to a contradiction. For example, if an increase in output from 91
to q, caused total costs to decline, it must be the case that the firm was not minimizing
costs in the first place. It should have produced g, and thrown away an output of
4,-4, thereby producing g, at alower cost. Similarly, ifan increase in the price of an
input ever reduced total cost, the firm could not have been minimizing its costs in the
first place. To see this, suppose the firm was using the input combination k,,4 and that
w increases. Clearly that will increase the cost of the initial input combination. But if
changes in input choices actually caused total costs to decline, that must imply that there
was a lower-cost input mix than k, ,4 initially. Hence we have a contradiction, and this
property of cost functions is established.7
3. Total cost functions are concave in input prices. It is probably casiest to illustrate this
property with a graph. Figure 10.6 shows total costs for various values of an input
price, say, n, holding q and vconstant. Suppose that initially a wage rate of w1 prevails
FIGURE 10.6 Cost Functions Are Concave in Input Prices

With a wage rate of w, total costs of producing q, are C(v, w,9). Ifthe irm docs not change its
input mix, costs of producing 4, would follow the straight line CpSEUDO- With input substitution,
actual costs C(, w, 4,) will fall below this linc, and hence the cost function is concave in w.

Costs

.CpSEUDO
Cv,w.q)

C(v,w,4)

W. W

and that the total costs associated with producing g, are given by C(", ",, 4,). Ifthe
firm did not change its input mix in response to changes in wages, then its total cost
curve would be linear as reflected by the line CpsEUDoD, ", 4) = Dk, + wl, in the
igure. Buta cost-minimizing firm probably would change the input mix it uses to
produce q, when wages change, and these actual costs |C(", , 4)] would fall below
the "pseudo" costs. Hence, the total cost function must have the concave shape
shown in Figure 10.6. One implication of this finding is that costs will be lower
when a firm faces input prices that fluctuate around a given level than when they
remain constant at that level. With fluctuating input prices, the firm can adapt its input
mix to take advantage of such fluctuations by using a lot of, say, labor when its price is
low and economizing on that input when its price is high.
4. Average and marginal costs. Some, but not all, of these properties of total cost
functions carry over to their related average and marginal cost functions. Homogeneity
is one property that carries over directly. Because C(tv, tw, q) = tC(v, r, q), we have
AC(tv, tw, q) =
C(t, tw, 9) tC(v, w, 4) = tAC(P, w, 4) (10.27)
and8
aC(t, tw, q) tòC(P, w, q)
MC(tv, tw, q) = = tMC(p, W, q). (10.28)
dg dg
 and that the total costs associated with producing q, are given by C(", ", 4). If the
firm did not change its input mix in response to changes in wages, then its total cost
curve would be linear as reflected by the line CrsEUDO(, ", 4) = Pk, + wl, in the
figure. But a cost-minimizing firm probably would change the input mix it uses to
produce g; when wages change, and these actual costs (C(v, ", 4,)] would fàll below
the "pseudo" costs. Hence, the total cost function must have the concave shape
shown in Figure 10.6. One implication of this finding is that costs will be lower
when a firm faces input prices that fluctuate around a given level than when they
remain constant at that level. With fluctuating input prices, the firm can adapt its input
mix to take advantage of such fluctuations by using a lot of, say, labor when its price is
low and economizing on that input when its price is high.
4. Average and marginal costs. Some, but not all, of these properties of total cost
functions carry over to their related average and marginal cost functions. Homogencity
is one property that carries over directly. Because C(rn, tw, q) = C(r, w, g), we have
AC(to, tw, q) = C(t, t, 9)C(, ", 4) = tAC(, w, q) (10.27)
and&

MC(tv, tw, q) = aC(t, tw,9) tò C(v, w, 9) =

tMC(v, W, 4). (10.28)
dg

his result does not violate the theorem that the derivative of a function that is
cdegree k-1, because we are differentiating with respect to g and total costshomogencous
are
of degree kis homogencous
ces only. homogeneous with respect to input

Part 3 Production and Supply

The cffects of changes in q, v, and w on average and

ambiguous, however. We have already shown that average marginal costs are sometimes
may have negatively sloped segments, so neither AC nor MC and marginal cost curves
Because total costs must not decrease when an input price is nondecreasing in q.
cost is increasing in wand p. But the case of rises, it is clear that average
marginal cost is more complex. The main
complication arises because of the possibility of input
rare) case, an increase in an inferior input's price inferiority. In that (admittedly
decline. Although the proof of this is relatively will actually cause marginal cost to
nation for it is clusive. Still, in most cases, it seems straightforward,
an intuitive expla
clear that the increase in the price
of an input will increase marginal cost as
vwell.