Intermediate Microeconomics Module 7 Minimizing Costs

COSTS 129 CHAPTER Minimizing Costs THE POLICY QUESTION WILL AN INCREASE IN THE MINIMUM WAGE DECREASE EMPLOYMENT ?

Recently , a policy topic in the United States is the idea of increasing minimum wages as a response to poverty and growing income inequality . There are many questions of debate about mum wages as an effective policy tool to tackle these problems , but one common criticism of minimum wages is that they increase unemployment . In this chapter , we will study how firms decide how much of each input to employ in their production ofa good or service . This knowledge will allow us to address the question of whether firms are likely to reduce the amount of labor they employ if the minimum wage is increased . In order to provide goods and services to the marketplace , firms use inputs . These inputs are costly , so firms must be smart about how they use labor , capital , and other inputs to achieve a certain level of output . The goal of any profit maximizing firm is to produce any level of output at the minimum cost . Doing anything else can not be a profit maximizing strategy . This chapter studies the cost minimization problem for firms how to most efficiently use inputs to produce output . EXPLORING THE POLICY QUESTION Read the Labor Day Turns Attention Back to Debate article and answer the following questions What potential benefits to raising the minimum wage are identified in the article ?

What potential disadvantages to raising the minimum wage are identified ?

LEARNING OBJECTIVES The Economic Concept of Cost Learning Objective Explain fixed and variable costs , opportunity cost , sunk cost , and depreciation . Cost Minimization Learning Objective Describe the solution to the cost minimization problem in the short run . 129

130 PATRICK EMERSON Cost Minimization Learning Objective Describe the solution to the cost minimization problem in the long run . When Input Costs and Output Change Learning Objective Analyze the effect of changes in prices or output on total cost . Policy Example Will an Increase in the Minimum Wage Decrease Employment ?

Learning Objective Apply the concept of cost minimization to a policy . THE ECONOMIC CONCEPT OF COST Learning Objective Explain fixed and variable costs , opportunity cost , sunk cost , and depreciation . From the described in chapter , we know that firms have many choices of input to produce the same amount of output . Each point on an represents a different tion of inputs that produces the same amount of output . Of course , inputs are not free the firm must pay workers for their labor , buy raw materials , and buy or rent machines , all of which are costly . So the key question for firms is , Which point on an is the best choice ?

The answer is the point that represents the lowest cost . The topics of this chapter will help us locate that point . This chapter studies production is , how costs are related to output . In order to draw a cost curve that shows a single cost for each output amount , we have to understand how firms make the sion about which set of possible inputs to use to be as efficient as possible . To be as efficient as possible means that the firm wants to produce output at the lowest possible cost . For now , we assume that firms want to produce as efficiently as other words , minimize costs . Later , in chapter , Profit Maximization and Supply , we will see that producing at the lowest cost is what profit maximizing firms must do ( otherwise , they can not possibly be maximizing ) Agood way to think about the cost side ofthe firm is to consider a manager who is in charge of running a factory for a large company . She is responsible for producing a specific amount of output at the lowest possible cost . She must choose the mix of inputs the factory will use to achieve the production target . Her task , in other words , is to run her factory as efficiently as possible . She does not want to use any extra inputs , and she does not want to pick a mix of inputs that costs more than another mix of inputs that produces the same amount of output . To make efficient or decisions , it is important to understand some basic cost concepts , starting with fixed and variable costs as well as opportunity costs , sunk costs , and depreciation . Fixed and Variable Costs cost is a cost that does not change as output changes . For example , a firm might need to pay for the lights to be on in order for the workers to see what they are doing and for production to happen . But the lights are simply on or off , and the cost of powering them does not change when output changes .

COSTS 131 A variable cost is a cost that changes as output changes . For example , a firm that wishes to produce more output might need to employ more labor hours by either hiring more workers or having existing workers work more hours . The cost of this labor is therefore a variable cost , as it changes as the output level changes . Opportunity Costs As we learned in chapter , the opportunity cost of something is the value of the next best alternative given up in order to get it . Suppose a firm has access to an input that it can use in production without paying a price for it . A ple example is a family farm . The farm uses land , water , seeds , fertilizer , labor , and farm machinery to produce a say it then sells in the marketplace . If the farm owns the land it uses to produce the corn , do we then say that the land component is not part ofthe firm costs ?

The answer , of course , is no . When the farm uses the land to produce corn , it any other use of the land that is , it gives up the opportunity to use the resource for another purpose . In many cases , the opportunity cost is the market value of the input . For example , suppose an alternative use for the land is to rent it to another farmer . The forgone rent from the decision to use the land to produce its own corn is the farm opportunity cost and should be factored into the production decision . opportunity cost , which in this case is the rental fee , is higher than the profit the farm will earn from producing corn , the most efficient economic decision is to rent out the land instead . Now consider the more complex example of a farm manager who is told to produce a certain amount of corn . Suppose that the manager figures out that she can produce exactly that amount using a variety of corn and all the available land . She also knows that another way to produce the same amount of corn is with a variety that requires a lot more fertilizer but uses only 75 percent of the land . The additional fertilizer for this corn will cost an extra . Which option should the farm manager choose ?

Without considering the opportunity cost , she would use the variety of corn and all of the land because it costs less than the alternative method . But what if , under the alternative method , she could rent out for the 25 percent of the land that would not be planted ?

In that case , the decision is actually to use the corn variety and rent out the unused land . Another classic example is that of a small business owner who runs , say , a coffee shop . The inputs into the coffee shop are the labor , the coffee , the electricity , the machines , and so on . But suppose the owner also works a lot in the shop . He does not pay himself a salary but simply pays himself from the shop excess revenues , or revenues in excess of the cost of the other inputs . The cost of his the shop is not but the amount he could earn working elsewhere instead . If , for example , he could work in the local bank for a month , then the opportunity cost of his working at the coffee shop is , and if the excess revenues are less than , he should close the shop and work at the bank instead , assuming he likes both jobs equally well . Sunk Costs Some costs are recoverable , and some are not . An example of a recoverable cost is the money a farmer spends on a new tractor knowing that she can turn around and it for the same amount she paid .

132 PATRICK EMERSON cost is an expenditure that is not recoverable . An example ofa sunk cost is the cost ofthe paint a business owner uses to paint the leased storefront of his coffee shop . Once the paint is on the wall , it has no resale value . Many inputs reflect both recoverable and sunk costs . A business that buys a car for an employee use for and can resell it for should consider of its expenditure a sunk cost and a recoverable cost . Why do sunk costs matter in choosing inputs ?

Because after incurring sunk costs , a manager should not consider them in making subsequent decisions . Sunk costs have no bearing on such decisions . To see this , suppose you buy a 500 and airline ticket to go to Florida during spring break . However , as spring break approaches , you are invited by friends to spend the break at a mountain cabin they have rented to which they will give you a ride in their car at no cost to you . You fer to spend the break with your friends in the cabin , but you have already spent the 500 on the ticket , and you feel compelled to get your money worth by using it to go to Florida . Doing so would be the wrong decision . At the time of your decision , the 500 spent on the ticket is and fore a sunk cost . Whether you go to Florida or not , you can not get the 500 back , so you should do what makes you most happy , which is going to the cabin . Depreciation Depreciation is the loss of value ofa durable good or asset over time . A durable good is a good that has a long usable life . Durable goods are things like vehicles , factory machines , or appliances that generally last many years . The difference between the beginning value ofa durable good and its value sometime later is called depreciation . Most durable goods depreciate machines wear out newer , more advanced ones are produced , thus reducing the value of current ones and so on . Suppose you are a manager who runs a factory that uses a large machine . How does the machine depreciation factor into the cost of using it ?

The appropriate way to think about these costs is through the lens of opportunity cost . If your factory did use the machine , you could rent it to another firm or sell it . Let consider the selling of the machine . Suppose it costs to purchase the machine new , and it at a rate of per month , meaning that each month , its resale value drops by . Note that the purchase cost of the machine is not sunk because it is each month , the recoverable amount diminishes with the rate of depreciation . So , for example , exactly one year after purchase , the machine is worth . At this point in time , the depreciation has become a sunk cost . However , at the current point in time , you have a choice you can sell the machine for or use it for a month and sell it at the end of the month for . The opportunity cost of using the machine for this month is exactly in depreciation . Why does depreciation matter in choosing inputs ?

Well , suppose workers can do the same job as the machine , or in economics parlance , suppose you can substitute workers for capital . To produce the same amount of pencils as the machine , you need to add labor hours at a rate of 900 a month . A manager without good economics training might think that since the firm purchased the machine , the machine is free , and since the labor costs 900 a month , use the machine . But manager well trained in that the monthly cost of using the machine is the drop in resale value ( the cost ) and the monthly cost ofthe labor is 900 . You will save the company 100 a month by using the labor and selling the machine .

COSTS 133 COST MIN Learning Objective Describe the solution to the cost minimization problem in the short run . In order to maximize profits , firms must minimize costs . Cost minimization simply implies that firms are maximizing their or using the lowest cost amount of inputs to produce a specific output . In the short run , firms have fixed inputs , like capital , giving them less flexibility than in the long run . This lack of flexibility in the choice inputs tends to result in higher costs . In chapter , we studied the production function ( where is output , is the input , and is capital . The bar over indicates that it is a fixed input . The cost minimization problem is straightforward since the only adjustable input is labor , the solution to the problem is to enough labor to produce a given level of output . Figure illustrates the ion to the cost minimization problem . Since capital is fixed , the decision about labor is to choose the amount that , combined with the available capital , enables the firm to produce the desired level of output given by the . Capital , Labor Figure cost From figure , it is clear that the only level of the variable input , labor , is at . To see this , note that any level of labor below would yield a lower level of output , and any level of labor above would yield the desired level of output but would be more costly than because each unit of labor employed must be paid for . Mathematically , this problem requires only that we solve the following production function for

134 PATRICK EMERSON ( Solving the production function requires that we invert it , which we can do only if the function is monotonic . This requirement is satisfied for our production functions because we assume that output always increases when inputs increase . i ( Let consider a specific example ofa production function To find the level of labor input , we need to solve this equation for ( This simplifies to 100 ?

Note that this equation does not require a specific output target but rather gives us the level of labor for every level of output . We call this an function a function that describes the optimal factor input level for every possible level of output . 73 COST MINIMIZATION Learning Objective Describe the solution to the cost minimization problem in the long run . The long run , by definition , is a period of time when all inputs are variable . This gives the firm much more flexibility to adjust inputs to find the optimal mix based on their relative prices and relative . This means that the cost can be made as low as possible , and generally lower than in the short run . Total Cost in the Long Run and the Line For a , production function , the total cost of production is the sum of the cost of the labor input , and the capital input , The cost of labor is called the wage rate , 11 ) The cost of capital is called the rental rate , The cost of the labor input is the wage rate multiplied by the amount of labor employed , The cost of capital is the rental rate multiplied by the amount of capital , The total cost ( therefore , is ( If we hold total cost constant , we can use this equation to find lines . An line is a graph of every possible combination of inputs that yields the same cost of production . By picking a cost , and given wage rates , 11 ) and rental rates , we can find all the combinations of and that solve the equation and graph the line .

COSTS 135 Consider the example of a factory , where both capital in the form of machines and labor to run those machines are utilized . Suppose the wage rate of labor for the pencil maker is 20 per hour and the rental rate of capital is 10 per hour . total cost of production is 200 , the firm could be employing ten hours of labor and no capital , twenty hours of capital and no labor , five hours of labor and ten hours of capital , or any other combination of capital and labor for which the total cost is 200 . Figure illustrates this particular line . Capital Line , Labor Figure An line This figure represents the line where total cost equals 200 . But we can draw an line that is associated with any total cost level . Notice that any combination of labor hours and capital that is less expensive than this particular line will end up on a lower line . For example , two hours of labor and five hours of capital will cost 90 . Any combination of hours of labor and capital that are more expensive than this particular line will end up on a higher line . For example , twenty hours of labor and thirty hours of capital will cost 700 . Note that the slope of the line is the ratio of the input prices , This tells us how much of one input ( capital ) we have to give up to get one more unit of the other input ( labor ) and maintain the same level of total cost . For example , if both labor and capital cost 10 an hour , the ratio would be 10 or . This is they cost the same amount , to get one more hour of labor , you need to give up one hour of capital . In our example , labor is 20 per hour , and capital is 10 per hour , so the ratio is to get one more hour of labor input , you must give up two hours of capital in order to maintain the same total cost or remain on the same line .

136 PATRICK EMERSON The solution to the cost minimization problem is illustrated in figure . The plant manager problem is to produce a given level of output at the lowest cost possible . A given level of output to a particular , so the cost minimization problem is to pick the point on the that is the lowest cost of production . This is the same as saying the point that places the firm on the est line . We can see this by examining figure and noting that the point on the that corresponds to the lowest line is the one where the is tangent to the . Capital , Labor Figure Solution to the cost minimization problem From figure , we can see that the optimal solution to the cost minimization problem is where the cost and are tangent the point at which they have the same slope . We just learned that the slope of the is ' and in chapter , we learned that the slope ofthe is the marginal rate of technical substitution ( which is the ratio of the marginal product of labor and capital So the solution to the cost minimization problem is , or ) This can be rearranged to help with intuition

COSTS 137 ( Equation ( says that at the mix of inputs the marginal products per dollar must be equal . This conclusion makes sense if you think about what would happen if equation ( 752 ) did not hold . Suppose instead that the marginal product of capital per dollar was more than the marginal product of labor per dollar This inequality tells us that this current use of labor and capital can not be an optimal solution to the cost minimization problem . To understand why , consider the effect a dollar spent on labor input away , thereby lowering the amount of labor input ( raising the the law of diminishing marginal returns ) and spending that dollar instead on capital and increasing the capital input ( lowering the ) We know from the inequality that if we do this , overall output must increase because the additional output from the extra dollar spent on capital has to be greater than the lost output from the diminished labor . Therefore , the net effect is an increase in overall output . The same argument applies if the inequality were reversed . An Example of Minimizing Costs in the Long Run Consider a specific example of a gourmet root beer producer whose labor cost is Calculus ( Cost Minimization Problem ) 20 an hour and whose capital cost Is an hour . Suppose the production tion for a barrel of root beer , is . output target is one thousand barrels of root beer , they could , for example , utilize one hundred hours of labor , and one hundred hours of capital , to yield 10 ( 10 ) 10 ) 17 000 barrels of root beer . But is this the most way to do it ?

More generally , what is the most mix of labor and to produce one thousand barrels of root beer ?

To determine this , we must start with the marginal products of labor and , which for this production function are the following ( Mathematically , we express the cost minimization problem in the lowing way we want to minimize total cost subject to an output target min ( subject to ( We can proceed by defining a function ( A ) where A is the multiplier . The conditions for an interior ( are as follows ( Au ( 74 ) aL ( aA , a ( From chapter , we know that and (

138 Substituting these in and combining and to get rid of the multiplier yields expression ( LU ( And is the constraint ( Equations ( and ( are two equations in two unknowns , and and can be solved by repeated substitution . Note that these are exactly the that describe figure . Equation ( is the mathematical expression of ' and equation ( pins us down to a specific , as ' holds fora number of and lines depending on the chosen . PATRICK EMERSON And thus the , is The ratio in this case is , or . So the condition that characterizes the level of input utilization is , or . That is , for every hour of labor employed , the firm should utilize four hours of capital . This makes sense when you think about the fact that labor is four times as as capital . Now , what are the specific amounts ?

To find them , we substitute our ratio into the duction function set at one thousand barrels ) 100 , then ( equals fifty . 50 , then 200 . So using fifty hours of labor and two hundred hours of capital is the most way to produce one thousand barrels of root beer for this firm . Calculus . For the following questions , the , 30 an hour , and hour , and the production target . a . Find the marginal product . Find the marginal product . Find the . Find the optimal amount and capital inputs . in the method . WHEN INPUT COSTS AND OUTPUT CHANGE For and 11 and , functions using Learning Objective Analyze the effect of changes in prices or output on total cost . In the previous section , we determined the combination of labor and capital to one thousand barrels of root beer . As long as the prices of labor and capital remain constant , this producer will continue to make the same choice for every one thousand barrels of root beer produced . But what happens when input prices change ?

COSTS 139 Suppose , for example , an increasing demand for the capital equipment used to make root beer drives the rental price up to 10 an hour . This means capital is more expensive than before not only in absolute terms but in relative terms as well . In other words , the opportunity cost of capital has increased . Before the price increase , for every extra hour of capital utilized , the root beer firm had to give up of an hour of labor . After the rental rate increase , the opportunity cost has increased to an hour of labor . A minimizing firm should therefore adjust by utilizing less ofthe relatively more expensive input and more of the relatively less expensive input . to 20 In this case , the ratio is now , or . So the new condition that characterizes the 10 level of input utilization after the price change IS I , or The production function for one thousand barrels has not changed 100 50 then , 000 ( which equals roughly 71 . 71 , then 142 . As expected , the firm now uses more labor than it did prior to the price change and less capital . We can also calculate and compare the total cost before and after the increase in the rental rate for capital . Total cost is , so in the first case where is 20 and is , the total cost IS ( 20 ( 20 ( 50 ) 200 ) 000 . Now when capital rental rates increase to 10 , total cost becomes ( 20 ( 10 ( 20 ( 71 ) 10 ( 142 ) This new higher cost makes sense because the production function did not change , so the firm remained constant , wages remained constant , but rental rates increased . So overall , the firm saw a cost increase and no change in productivity , leading to an increase in production costs . Expansion Path A firm expansion path is a curve that shows the amount of each input for every level of output . Let look at an example to see how the expansion path is derived . Equation ( describes the production function set to the specific production target of one thousand barrels of root beer . If we replace one thousand with the output level we get the following expression ( We use the ratio of capital to labor that characterizes the ratio when the wage rate for labor is 20 an hour and the rental rate for capital is an hour ,

140 PATRICK EMERSON IfL ( i , 20 20 So using fifty hours of labor and two hundred hours of capital is the most way to produce one thousand barrels of root beer for this firm . Note that ( and ( are both functions These are the 20 demand functions . functions describe the optimal , or , amount of a specific production input for every level of output . Note that when the output , 50 and 200 , just as we found before . But from these factor demands , we can immediately find the optimal amount of labor and capital for any output target at the given input prices . For example , suppose the factory wanted to increase output to two thousand or three thousand barrels of root beer Arc ) 000 ( To ( We can graph this firm expansion path ( figure ) from the input demands when equals one sand , two thousand , and three thousand . We can also immediately derive the total cost curve from these factor demands by putting them into the cost function , i ( 1020 At input prices 11 ) 20 and ' the function becomes 20 . The total cost curve shows us the specific total cost for each output amount when the firm is minimizing input costs . Graphically , the expansion path and associated total cost curve look like figure .

COSTS 141 Capital , Expansion path 2000 3000 2000 50 100 150 Labor , Figure The expansion path and cost curve Figure illustrates how the solution to the cost minimization problem translates into factor demands and total cost . We can solve for the factor demands and the total cost function more generally by replacing our specific input prices with and in the following way . The solution to the cost problem is characterized by the equaling the input price ratio the and . the , so or , or We can plug this into the production function to get 10 ( 10 ( to Solving for the input demand for capital yields 11 ) 10 . Since the input demand for labor 10 11 ) Now we have functions that are functions of both output , and the input prices , to and . Note that when rises , the inputs of both capital and labor rise as well . Also note that when the

142 PATRICK EMERSON price of labor , rises relative to the price of capital , or when rises , the use of the capital input rises and the use of the labor input falls . And when the price of capital rises relative to the price of labor , the use of labor rises , and the use of capital falls . So from these functions , we can see the firm optimal adjustment to changing input costs in the form of substituting the relatively cheaper input for the more expensive input . Perfect Complement and Perfect Substitute Production Functions Perfect complements and perfect substitutes in production are not uncommon . Suppose our ing firm needs exactly one operator ( labor ) to operate one machine . A second worker per machine adds nothing to output , and a second machine per worker also adds nothing to output . In this case , the firm would have a perfect complement production function . Alternatively , pose our root beer producer could either use two workers ( labor ) to measure and mix up the ingredients or employ one machine to do the same job . Either combination yields the same output . In this case , the root beer producer would have a perfect substitute production function . Similar to the consumer choice problem , for production functions where inputs are perfect or substitutes , the condition that equals the price ratio will no longer hold . To see this , sider a ) Figure The cost minimization solution for perfect complements ( a ) and perfect substitutes (

MINIMIZING COSTS 143 In panel ( a ) a perfect complement intersects the line at the corner of the . Take a moment and confirm to yourself that any other combination of labor and capital on the would be more expensive . However , at the corner of the , the slope is undefined , so there is no . For perfect complements , using inputs in any combination other than the optimal ratio is not cost minimizing . So we can immediately express the optimal ratio as a condition of cost . If the duction function is of the perfect complement type , min aL , the optimal input ratio is aL And since output is equal to the minimum ofthe two arguments ofthe function , that means ( So the optimal amount for any output level is , and . a Panels ( and ( of figure show the optimal solution to the cost minimization problem when the production function is a perfect substitute type . The solution is on one corner or the other of the line , depending on the marginal of the inputs and their costs . In ( the or the slope of the is lower ( less steep ) than the slope of the line or the ratio of the input prices . Since this is the case , it is much less costly to employ only capital to produce In ( the or the slope of the is higher ( steeper ) than the slope of the line or the ratio of the input prices . Since this is the case , it is much less costly to employ only labor to produce Recall that a perfect substitute production function is of the additive type aL The marginal product of labor is or , and the marginal product of capital is oz Since the is the ratio of the marginal products , the is , which is also the slope of the . The ratio of input prices is . This price ratio is the slope of the . 01 From the graphs we can see that if , or the is less steep than the , only capital is used , thus we know that no labor will be employed , or , and output must equal or , or Solving this for gives us . Alternatively , if , only labor is used , so ( aL , andL a POLICY EXAMPLE WILL AN INCREASE IN THE MINIMUM WAGE DECREASE EMPLOYMENT ?

Learning Objective Apply the concept of cost minimization to a policy . On May 15 , 2014 , the city of Seattle , Washington , passed an ordinance that established a minimum wage of an hour , almost more than the statewide minimum wage and more than double the eral minimum of an hour . A minimum wage increase brings up many issues about its impact , particularly for a city surrounded by suburbs that allow much lower rates of pay . One question we can answer with our current tools is how businesses affected by the increased minimum wage are likely to react to the higher cost of labor . Most businesses that employ labor have many other inputs as well , some of which can be substituted for labor . Consider a janitorial firm that sells services to office buildings , restaurants , and

144 PATRICK EMERSON industrial plants . firm can choose to clean floors using a small amount of capital and a large amount of labor they can employ many cleaners and equip them with a simple mop . from Nick Alpha Stock images is under Or they could choose to employ more capital in the form ofa modern machine and employ fewer cleaners .

MINIMIZING COSTS 145 Image on commons . org is licensed under Our theory of cost minimization can help us understand and predict the consequences of making the labor input for cleaning the floors 50 percent more expensive . Figure shows a typical firm cost minimization problem . It is reasonable to consider the long run in this case because it would not take the firm very long to lease or purchase and have delivered a machine . It is also reasonable to assume that machines and workers are substitutes but not perfect that machines can be used to replace some labor hours , but some machine operators are still needed . The opposite is also true the restaurant can replace machines with labor , but labor needs some capital ( a simple mop ) to clean a floor . Capital , Labor Figure Change in inputs due to increase in Wages

146 PATRICK EMERSON In figure , the , represents the fixed amount of floor the firm needs to clean each day and the different combinations of capital and labor it can use to achieve that output target . When the cost of labor , increases and the cost of capital , stays the same , the line gets steeper as increases . We can see in the figure that when this happens , the firm will naturally shift away from using the relatively more expensive input and toward the relatively cheaper input . The restaurant will decrease the amount of labor it employs and increase the amount of capital it uses . From this specific firm , we can generalize that a dramatic permanent increase in the minimum wage will cause affected firms to employ fewer hours of labor and that employment overall will fall in the affected area . The magnitude change caused by such a policy depends on the production technology of all affected is , how easy it is for them to substitute more capital . All we can predict with our model currently is the fact that such shifts away from labor will likely occur . Whether the cost of this decrease in employment is outweighed by the benefit of such a policy is beyond the scope ofthe current analysis , but our model of cost minimization has provided useful insight into the decisions firms will make in reaction to the increase in minimum wage . EXPLORING THE POLICY QUESTION . Do you support a national minimum wage increase ?

Why or why not ?

Do you think the benefits ofa minimum wage increase outweigh the costs ?

Explain your answer . What do you predict would happen if , instead ofa minimum wage , a tax on the purchase or rental of capital equipment was imposed ?

REVIEW TOPICS AND LEARNING OUTCOMES The Economic Concept of Cost Learning Objective Explain fixed and variable costs , opportunity cost , sunk cost , and depreciation , Cost Minimization Learning Objective Describe the solution to the cost minimization problem in the short run . Cost Minimization Learning Objective Describe the solution to the cost minimization problem in the long run . When Input Costs and Output Change Learning Objective Analyze the effect of changes in prices or output on total cost .

MINIMIZING COSTS 147 Policy Example Will an Increase in the Minimum Wage Decrease Employment ?

Learning Objective Apply the concept of cost minimization to a policy . LEARN KEY TOPICS Terms Fixed cost A cost that does not change as output changes . Variable cost A cost that changes as output changes . Sunk cost An expenditure that is not recoverable , ie , the cost of the paint a business owner uses to paint the leased storefront of his coffee shop . Depreciation The loss of value of a durable good or asset over time . Durable good A good that has a long usable life . function A function that describes the optimal factor input level for every possible level of output , ie , line A graph of every possible combination of inputs that yields the same cost of production . Graphs cost minimization

148 PATRICK EMERSON , Capital , Labor An line , Capital Line An Solution to the cost minimization problem MINIMIZING COSTS 149 , Capital , Labor cost problem The expansion path and cost curve Capital , Expansion path ( 100 ( 50 100 150 Labor , The expansion path and cost ( The cost minimization solution for perfect complements and perfect substitutes 150 PATRICK EMERSON The cast perfect complements ( a ) and perfect ( Change in inputs due to increase in wages , Capital , Labor Changes in due to wages Equations Total cost MINIMIZING COSTS 151 ( Marginal rate of technical substitution ( The is also the slope of the cost minimization problem The slope of the is the , and the slope of the is So the solution to the cost minimization problem is i LU This formula has many different calculus derived conclusions that should be reviewed .