The Cost of Production 237business. By contrast, online sellers such as Amazon care only about maximiz-
ing 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 functionindicates 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 fos-
ter 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 lim-
ited 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 addi-
tional 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 expen-
ditures on labor, capital, materials, and any other inputs and including any rel-
evant opportunity costs, as discussed in the previous section. For concreteness,
consider a firm that provides a service—say, electronic repair. Figure 6.1 pro-
vides a summary of the repair firm’s costs as they vary for different quantities
of output (number of repair jobs completed).c06CostAnalysis.qxd 9/29/11 1:46 PM Page 237