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  • Print publication year: 2016
  • Online publication date: May 2018

8 - Production costs and the theory of the firm

from Book III - Demand and production theory


The economist's stock in trade – his tools – lies in his ability to and proclivity to think about all questions in terms of alternatives. The truth judgment of the moralist, which says that something is either wholly right or wholly wrong, is foreign to him. The win–lose, yes–no discussion of politics is not within his purview. He does not recognize the either–or, the all-or-nothing situation as his own. His is not the world of the mutually exclusive. Instead, his is the world of adjustment, of coordinated conflict, of mutual gain.

James M. Buchanan

Amazing things happen when people take responsibility for everything themselves. The results are quite different, and at times people are unrecognizable. Work changes and attitudes to it, too.

Mikhail Gorbachev, former Premier of the Soviet Union

Cost is pervasive in human action. Managers (as well as everyone else) are constantly forced to make choices, to do one thing and not another. Cost – or more precisely, opportunity cost – is the most highly valued opportunity not chosen. Although money is the most frequently used measure of cost, it is not cost itself.

Although we may not recognize it as such, cost also pervades our everyday thought and conversation. When we say “that course is difficult” or “the sermon seemed endless” or “changes to the product design at this stage can't be made,” we are probably more often than not indicating something about the cost involved. If the preacher's extended commentary delayed the church picnic, the sermon was costly. Although complaints about excessive costs sometimes indicate an absolute limitation, more often they merely mean that the benefits of the activity are too small to justify the cost. Many people who “can't afford” a vacation actually have the money but do not wish to spend it on travel, and most students who find writing research papers “impossible” are simply not willing to put forth the necessary effort.

This chapter explores the meaning of cost in business, specifically, and in human behavior, generally. We begin by showing how the hidden costs of a choice often can explain seemingly irrational behavior. We then develop further the concept of marginal cost which, together with the related concepts of demand and supply, defines the limits of rational behavior, from personal activities such as painting and fishing to business decisions such as how much to produce.

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