BAM 040: Managerial Economics

SAS Module #19

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule:_____________________________________ Date:_______________

Lesson title: The Cost Function Materials:

Lesson Objectives: Student Activity Sheets
1. I can explain the difference between short run costs and long run References:
cost https://www.economicsdiscussion.
2. I can differentiate the economic relevance of fixed costs, sunk net/cost/cost-function-concept-and-
costs, variable costs and marginal costs. importance/16861
Managerial Economics Business
Strategy Ninth Edition by
Baye,Prince,2017
Investopedia.com

“Success consists of going from failure to failure

without loss of enthusiasm.”

A. LESSON PREVIEW/REVIEW
1) Introduction (2 min)
Good day my dear student! Our topic for today is all about Costs. I know you have lots of ideas about the
topic but before that, let’s check first if you still remember our topic last meeting.

Pre-Test/Review (3 min)
Direction: Identify the item described in each number.

_________________1. A form of production function where there is a perfect linear relationship

between all the inputs and total output.
_________________2. A form of production function which assumes some degree of substitutability
between inputs, albeit not perfect substitutability.
_________________3. The additional output produced as a result of employing an additional unit of the
variable factor input.
_________________4. Also called the fixed proportions production function because it implies that inputs
are used in fixed proportions
_________________5. It is defined as the output per unit of factor inputs.

1
This document and the information thereon is the property of PHINMA Education
 BAM 040: Managerial Economics
SAS Module #19

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule:_____________________________________ Date:_______________

B.MAIN LESSON
1) Activity 2: Content Notes (60 min)

THE COST FUNCTION

The relationship between output and costs is expressed in terms of cost function. By incorporating prices
of inputs into the production function, one obtains the cost function since cost function is derived from
production function. However, the nature of cost function depends on the time horizon. In microeconomic
theory, we deal with short run and long run time.

Cq = f(Qf, Pf)

Where:
Cq = the total production cost
Qf = the quantities of inputs employed by the firm
Pf = the prices of relevant inputs

SHORT RUN COSTS VS. LONG RUN COSTS

Short-Run Costs Long Run Costs

1. Definition Long run costs are accumulated when firms Short run costs are accumulated in real
change production levels over time in time throughout the production
response to expected economic profits or process. Fixed costs have no impact of
losses. In the long run there are no fixed short run costs, only variable costs and
factors of production. The land, labor, revenues affect the short run
capital goods, and entrepreneurship all vary production. Variable costs change with
to reach the the long run cost of producing the output.
a good or service.
2. As to cost With variable and fixed cost No fixed cost; all are treated as
variable cost

2
This document and the information thereon is the property of PHINMA Education
 BAM 040: Managerial Economics
SAS Module #19

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule:_____________________________________ Date:_______________

1. Total Cost
In economics, the total cost (TC) is the total economic cost of production. It consists of variable
costs and fixed costs. Total cost is the total opportunity cost of each factor of production as part
of its fixed or variable costs.

2. Variable Costs
Variable cost (VC) changes according to the quantity of a good or service being produced. It
includes inputs like labor and raw materials. Variable costs are also the sum of marginal costs
over all of the units produced (referred to as normal costs). For example, in the case of a clothing
manufacturer, the variable costs would be the cost of the direct material (cloth) and the direct
labor. The amount of materials and labor that is needed for each shirt increases in direct
proportion to the number of shirts produced. The cost “varies” according to production.

3. Fixed Costs
Fixed costs (FC) are incurred independent of the quality of goods or services produced. They
include inputs (capital) that cannot be adjusted in the short term, such as buildings and
machinery. Fixed costs (also referred to as overhead costs) tend to be time related costs,
including salaries or monthly rental fees. An example of a fixed cost would be the cost of renting a
warehouse for a specific lease period. However, fixed costs are not permanent. They are only
fixed in relation to the quantity of production for a certain time period. In the long run, the cost of
all inputs is variable.

4. Marginal Cost
In economics, marginal cost is the change in the total cost when the quantity produced changes
by one unit. It is the cost of producing one more unit of a good. Marginal cost includes all of the
costs that vary with the level of production. For example, if a company needs to build a new
factory in order to produce more goods, the cost of building the factory is a marginal cost. The
amount of marginal cost varies according to the volume of the good being produced

5. Average Cost
The average cost is the total cost divided by the number of goods produced. It is also equal to the
sum of average variable costs and average fixed costs. Average cost can be influenced by the
time period for production (increasing production may be expensive or impossible in the short
run). Average costs are the driving factor of supply and demand within a market.

3
This document and the information thereon is the property of PHINMA Education
 BAM 040: Managerial Economics
SAS Module #19

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule:_____________________________________ Date:_______________

Relationship Between Average and Marginal Cost

• When the average cost declines, the marginal cost is less than the average cost.
• When the average cost increases, the marginal cost is greater than the average cost.
• When the average cost stays the same (is at a minimum or maximum), the marginal cost equals
the average cost.

Sample Illustration:
Derivation of Average Costs
A B C D E F G
Variable Average Fixed Average Variable Average Total
Output Fixed Cost Cost Total Cost Cost Cost Cost

Given Given Given (B+C) (B/A) (C/A) (E+F)

0 2000 0 2000 - - -
76 2000 400 2400 26.32 5.56 31.58
248 2000 800 2800 8.06 3.23 11.29
492 2000 1200 3200 4.07 2.44 6.50
784 2000 1600 3600 2.55 2.04 4.59
1100 2000 2000 4000 1.82 1.82 3.64
1416 2000 2400 4400 1.41 1.69 3.11
1708 2000 2800 4800 1.17 1.64 2.81
1952 2000 3200 5200 1.02 1.64 2.66
2124 2000 3600 5600 0.94 1.69 2.64
2200 2000 4000 6000 0.91 1.82 2.73

4
This document and the information thereon is the property of PHINMA Education
 BAM 040: Managerial Economics
SAS Module #19

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule:_____________________________________ Date:_______________

Derivation of Marginal Costs

A B C D E F G
Variable
Output ∆Q Cost ∆VC Total Cost ∆TC Marginal Cost
Given Given Given Given (F/B)
0 0 0 2,000.00 - -
76 76 400 400 2,400.00 400.00 5.26
248 172 800 400 2,800.00 400.00 2.33
492 244 1200 400 3,200.00 400.00 1.64
784 292 1600 400 3,600.00 400.00 1.37
1100 316 2000 400 4,000.00 400.00 1.27
1416 316 2400 400 4,400.00 400.00 1.27
1708 792 2800 400 4,800.00 400.00 1.37
1952 244 3200 400 5,200.00 400.00 1.64
2124 172 3600 400 5,600.00 400.00 2.33
2200 76 4000 400 6,000.00 400.00 5.26

Activity 3: Skill-Building Activities (25min)

The table below shows the cost schedule. Let us assume that land per hectare costs 100 pesos per
production cycle (Fixed cost) while each unit of labor must be paid 5 pesos (variable cost per unit).

Direction: Fill in the missing values in the table.

Total Variable Total Total Total Marginal Average Average Average

Product Input Fixed Variable Cost (TC) Cost Cost Variable Fixed
(Labor) Cost Cost * (MC)* (AC)* Cost Cost
(TFC) (TVC) * (AVC)* (AFC) *
0 0 100 0 100 0 0.00 0.00 0.00
1 3 100 15 115 15 115.00 15.00 100.00
2 7 100
3 9 100
4 10 100
5 12 100
6 16 100
7 22 100
8 30 100
9 40 100
10 55 100
5
This document and the information thereon is the property of PHINMA Education
 BAM 040: Managerial Economics
SAS Module #19

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule:_____________________________________ Date:_______________

2) Activity 5: Check for Understanding (25min)

Labor Outpu TC MC TC MC
t
0 0
1 1
2 5
3 9
4 12
5 14
6 15

` 1. Pear; pwns a company that produces pools. 2. In the figure above is an ATC curve. In this figure
Pearl has total fixed cost of $2,000 a month and sketch an AVC curve and a MC curve.
Pays each of her workers $2,500 a month. The Tell what relationship these curves must
Table above shows the number of pools Pearl’s must obey so that they are drawn correctly.
Company can produce in a month.
a. Complete the left side of the table.
b. Suppose that the wage Pearl pays her workers
Increases to $3,000 a month. Complete the right
side of the table.
c. What was the effect of the wage hike on Pearl’s
Marginal cost?

Short answer and numeric questions

Write your answers on the box provided
1. If a firm closes and produces nothing, does it
still have any costs?
2. What is the difference between marginal cost
and average total cost?
3. Why is the average total cost curve U-shaped?
4. Where does the marginal cost curve interact the
average variable cost and average total cost
curves?
5. What two factors shift the cost curves?

6
This document and the information thereon is the property of PHINMA Education
 BAM 040: Managerial Economics
SAS Module #19

Name:______________________________________________________________ Class number: _______

Section: ____________ Schedule:_____________________________________ Date:_______________

C. LESSON WRAP-UP
1) Activity 6: Thinking about Learning (5mins)

A. Work Tracker
Congratulations! You are done with our session! Let’s track your progress. Shade the session number
you just completed.

B. Think about your Learning

1. How do you find our topic for today? What are your strategies in order to understand the topic?
___________________________________________________________________________________
_______________________________________________________________________________

2. What is your question about the topic?

___________________________________________________________________________________
_______________________________________________________________________________

Key to Corrections
Pre-Test
1. Linear 3. Marginal Product 5. Average Product
2. Cobb-Douglas 4. Leontief Production Function

Skill Building Activities

Total Variable Total Total Total Marginal Average Average Average
Product Input Fixed Variable Cost (TC) Cost Cost Variable Fixed
(Labor) Cost Cost * (MC)* (AC)* Cost Cost
(TFC) (TVC) * (AVC)* (AFC) *
0 0 100 0 100 0 0.00 0.00 0.00
1 3 100 15 115 15 115.00 15.00 100.00
2 7 100 35 135 20 67.50 17.50 50.00
3 9 100 45 145 10 48.33 15.00 33.33
4 10 100 50 150 5 37.50 12.50 25.00
5 12 100 60 160 10 32.00 12.00 20.00
6 16 100 80 180 20 30.00 13.33 16.67
7 22 100 110 210 30 30.00 15.71 14.29
8 30 100 150 250 40 31.25 18.75 12.50
9 40 100 200 300 50 33.33 22.22 11.11
10 55 100 275 375 75 37.50 27.50 10.00
Submit your activity sheets before the end of the session!

7
This document and the information thereon is the property of PHINMA Education