Cost Theory
Cost Theory in Economics
A central economic concept is that getting something requires giving up something else. For example, earning more money may require working more hours, which costs more leisure time. Economists use cost theory to provide a framework for understanding how individuals and firms allocate resources in such a way that keeps costs low and benefits high.
1. Function * Economists view costs as what an individual or firm must give up to get something else. Opening a manufacturing plant to produce goods requires an outlay of money. Once a plant owner spends money to manufacture goods, that money is no longer available for something else. Production facilities, machinery used in the production process and plant workers are all examples of costs.
Cost theory offers an approach to understanding the costs of production that allows firms to determine the level of output that reaps the greatest level of profit at the least cost. 2. Features * Cost theory contains various measures of costs. These include a firm's fixed costs and variable costs. The former do not vary with the quantity of goods produced. Rent on a facility is an example of a fixed cost. Variable costs change with the quantity produced. If increased production requires more workers, for example, those workers' wages are variable costs. The sum of fixed and variable costs is a firm's total costs. *
Additional Measures * Cost theory derives two additional cost measures. Average total cost is the total cost divided by the number of goods produced. Marginal cost is the increase in total cost that results from increasing production by one unit of output. Marginals--including marginal costs and marginal revenue--are key concepts in mainstream economic thought.
Falling and Rising Costs * Economists often use graphs, similar to supply-and-demand charts, to illustrate cost theory and firms' decisions about production. An average total cost curve is a
A central economic concept is that getting something requires giving up something else. For example, earning more money may require working more hours, which costs more leisure time. Economists use cost theory to provide a framework for understanding how individuals and firms allocate resources in such a way that keeps costs low and benefits high.
1. Function * Economists view costs as what an individual or firm must give up to get something else. Opening a manufacturing plant to produce goods requires an outlay of money. Once a plant owner spends money to manufacture goods, that money is no longer available for something else. Production facilities, machinery used in the production process and plant workers are all examples of costs.
Cost theory offers an approach to understanding the costs of production that allows firms to determine the level of output that reaps the greatest level of profit at the least cost. 2. Features * Cost theory contains various measures of costs. These include a firm's fixed costs and variable costs. The former do not vary with the quantity of goods produced. Rent on a facility is an example of a fixed cost. Variable costs change with the quantity produced. If increased production requires more workers, for example, those workers' wages are variable costs. The sum of fixed and variable costs is a firm's total costs. *
Additional Measures * Cost theory derives two additional cost measures. Average total cost is the total cost divided by the number of goods produced. Marginal cost is the increase in total cost that results from increasing production by one unit of output. Marginals--including marginal costs and marginal revenue--are key concepts in mainstream economic thought.
Falling and Rising Costs * Economists often use graphs, similar to supply-and-demand charts, to illustrate cost theory and firms' decisions about production. An average total cost curve is a