Microeconomics Economic Costs Are Both the Direct

Microeconomics

Economic costs are both the direct costs and the opportunity costs of a decision. There are a number of types of costs that are discussed in economics disciplines. These can be direct and indirect costs, but more common costs are things like marginal costs. These are the added cost associated with an increase in output. Microeconomics often focuses on things like marginal cost, and uses the economic cost concept to analyze individual purchase decisions. For example, we can deduce that while a degree might cost $40,000, it also carries with it an opportunity cost related to how much could have been earned flipping burgers during those four years. The economic cost of the degree therefore might be closer to $50,000. The concept of economic costs is often applied to production situations, where firms must make decisions about pricing an production levels based on analysis of the different types of economic costs.

There are other economic costs as well. Firms are often concerned with average cost, along with marginal cost, because that sort of information helps with pricing decisions. Thus fixed, variable, average and marginal costs are all part of economic discourse.

These different costs are important to understanding how businesses make their decisions with respect to pricing and production. There is a relationship, in that as a general rule the production level will decrease if the costs increase. This is because there will be a lesser contribution to fixed costs, something that affects profitability. To overcome this, the firm must be able to raise its prices. In many industries, prices are driven by the dynamics of the market and therefore it is not easy to raise prices -- the rigidity relates to the economic decision-making process.

2. If a firm is operating at a point where the average total cost is equal to the marginal cost then the firm is not making a profit. The firm might decide to build a bigger plant however, if it believes that a bigger plant might lower its average total cost. Often, there is an assumption that economies of scale can deliver lower average total costs for companies. This is not necessarily the case -- the company might spend so much on the new factory that its fixed costs rise higher than the variable costs fall.

3. The main circumstance in which a firm might continue to operate when it is losing money is if the loss is smaller than the fixed costs. Such a situation occurs because often a firm will be unable to vary a cost factor in the short run. If this is the case, the company might need to continue operating at a loss. In the long run, such a firm might exit the business. In the short-run however, the fixed cost might be significant to the extent that it is better for the firm to generate some contribution than no contribution at all. Thus, even if the firm makes no economic profit, it still makes a contribution to fixed costs. Again, in the long run the company probably would go out of business, but it would do so only after finding a way to eliminate that fixed cost.

Otherwise, there are few circumstances in which the firm would want to operate at a loss, unless it had reason to believe that the loss itself is temporary. This can happen if the firm believes it can sell more units, if it can change the price or if there is some other change in the industry conditions that will allow it to being turning a profit once again.