The Cost of Production
business. By contrast, online sellers such as Amazon care only about maximizing overall e-book revenue. It should not be surprising that book publishers and online sellers experience the same kinds of conflicts as franchisers and franchisees (discussed earlier in Chapter 2). As the spreadsheet problem at the close of the chapter shows, book publishers must carefully balance the two competing revenue sources in setting print book and e-book prices.
THE COST OF PRODUCTION As we noted in Chapter 5, production and cost are very closely related. In a sense, cost information is a distillation of production information: It combines the information in the production function with information about input prices. The end result can be summarized in the following important concept: The cost function indicates the firm’s total cost of producing any given level of output. The concept of a cost function was first introduced in Chapter 2. In this section, we take a much closer look at the factors that determine costs. A key point to remember is that the concept of the cost function presupposes that the firm’s managers have determined the least-cost method of producing any given level of output. (Clearly, inefficient or incompetent managers could contrive to produce a given level of output at some—possibly inflated—cost, but this would hardly be profit maximizing. Nor would the resulting cost schedule foster optimal managerial decision making.) In short, the cost function should always be thought of as a least-cost function. It usually is denoted as C C(Q) and can be described by means of a table, a graph, or an equation. As in our study of production, our analysis of cost distinguishes between the short run and the long run. Recall that the short run is a period of time so limited that the firm is unable to vary the use of some of its inputs. In the long run, all inputs—labor, equipment, factories—can be varied freely. Our investigation of cost begins with the short run.
Short-Run Costs In the basic model of Chapter 5, we focused on two inputs, capital and labor. In the short run, capital is a fixed input (i.e., cannot be varied) and labor is the sole variable input. Production of additional output is achieved by using additional hours of labor in combination with a fixed stock of capital equipment in the firm’s current plant. Of course, the firm’s cost is found by totaling its expenditures on labor, capital, materials, and any other inputs and including any relevant opportunity costs, as discussed in the previous section. For concreteness, consider a firm that provides a service—say, electronic repair. Figure 6.1 provides a summary of the repair firm’s costs as they vary for different quantities of output (number of repair jobs completed).
237
