Key Terms and Concepts

Other important cost concepts are the learning curve effect, cost complementarities,and economies of scope.The learning curve effect is the reduction in per-unit cost resulting from increased worker productivity due to increased worker experience.“Economies of scope”refers to the reduction in per-unit cost resulting from the joint production of two or more goods or services,such as the production of automobiles and trucks,or beef and leather,by the same producer.Cost complementarities exist when the marginal cost of producing one good is reduced by increasing the production of another good.

KEY TERMS AND CONCEPTS

Average fixed cost (AFC) Total fixed cost of production per unit of output. AFC is total fixed cost divided by total output (i.e., AFC =

TFC/Q).Average fixed cost is a short-run production concept.It is the average cost associated with the firm’s fixed factor of production. Average total cost(ATC) The total cost of production per unit of output:

ATC is total cost divided by total output (i.e., ATC = TC/Q).Average total cost is a short-run production concept if total costs include total fixed costs.It is a long-run production concept if all costs are variable costs. Average variable cost(AVC) Total variable cost of production per unit of output: AVC is total variable cost divided by total output (i.e., AVC =

TVC/Q). Constant returns to scale Output rises proportionately with the increase in all productive inputs,and per-unit costs remain constant. Cost complementarities When the marginal cost of producing one good is reduced by increasing the production of another good,there are cost complementarities. Direct cost Same as explicit cost. Diseconomies of scale An increase in long-run average total cost.It is conceptually related to the long-run production concept of decreasing returns to scale. Economies of scale A decrease in long-run average total cost.It is conceptually related to the long-run production concept of increasing returns to scale. Economies of scope Realized when the total cost of using a single production facility to produce two or more goods or services is lower than the cost of using separate production facilities. Experience curve effect A measure of the relation between an increase in per-worker productivity (a decrease in per-unit labor cost at fixed labor prices) associated with an improvement in labor skills from onthe-job experience,the adoption of new production,organizational,and

managerial techniques,the replacement of higher cost with lower cost materials,new product design,and so on. Explicit cost Sometimes referred to as out-of-pocket expenses,explicit costs are “visible”in the sense that they are direct payments for factors of production.Wages paid to workers and rental payments are examples of explicit costs. Implicit cost The value of the next best alternative use of a resource.

Implicit costs are “invisible”in the sense that no direct monetary payments are involved.They are the value of any forgone opportunities.

Implicit costs,however,may be made explicit. Incremental cost Related to the concept of marginal cost,incremental cost is the change in total cost associated with an innovation in management policy,such as introducing a new product line or changing in firm’s marketing strategy. Learning curve effect A measure of the relationship between an increase in per-worker productivity (a decrease in per-unit labor cost at fixed labor prices) associated with an improvement in labor skills resulting from on-the-job experience. Long-run average-total cost (LRATC) The least-cost combination of resources in the long run (i.e.,when all productive inputs are variable). Marginal cost (MC) The change in total cost of production associated with an incremental change in output. Minimum efficient scale (MES) The output level that corresponds to minimum long-run average total costs. Multiproduct cost function The total cost function that summarizes the cost of using the same production facilities to efficiently produce two or more products. Opportunity cost The highest valued forgone alternative associated with a decision. Sunk cost A cost that is invariant to innovations in management decisions, such as the introduction of a new product line or a change in marketing strategy.Sunk costs are not recoverable in the sense that once incurred, they are forever lost. Total cost (TC) The sum of total fixed cost and total variable cost.It is the total cost of production. Total economic cost All costs incurred during the production of a good or service.Total economic cost is the sum of explicitand implicit costs. Total fixed cost (TFC) A short-run production concept.Total fixed costs of production are associated with acquiring and maintaining fixed factors of production.Fixed costs are incurred by the firm regardless of the level of output.They are incurred by the firm even if no production takes place at all. Total variable cost (TVC) The cost associated with acquiring and maintaining variable factors of production.In stages I and II of production, total variable cost is an increasing function of the level of production.