Cost Theory and Cost Curves are important fundamental concepts that helps students understand the theories of profit maximisation, economics of scale and the differences between market structures. Costs Curves are dynamic models that change depending on the variable and fixed production costs of the firm. To develop the students understanding we used two main resources
- Google Spreadsheet with specific data at a range of output
- A PowerPoint presentation that explained the cost theories.
It is important to begin by teaching the Law of Diminishing Returns, usually with some fun game to simulate a business. For the last few years I have borrowed Jason Welker’s idea for a Paper Chain factory, see his excellent post and overview here. It is very simple activity, but helps students understanding the key concepts: Marginal Product and Total Product, given a fixed level of capital resources (scissors, staplers) in the Short Run.
Once we have completed the activity we talk about a case study for Bob the Builder. Bob is a bricklayer who leads a team of workers that make fences. We develop the key assumption that each worker offers different marginal returns to the business. The first second and third worker usually have increasing returns, but eventually subsequent workers will return marginally less output. This assumes a fixed level of capital resources in the short run such as diggers and machinery.
Based on this concept we can build into our analysis and understanding of costs. If each worker is contributing less to the fence then the marginal costs of putting extra bricks on the fence must start to increase. The key concept to highlight is
Increasing Marginal Returns = Decreasing Marginal Costs
Decreasing Marginal Returns = Increasing Marginal Costs
Then we can begin to look at a Google Spreadsheet with some variables.
Then students can use the same Google Spreadsheet to look at the typical costs for a firm. The power point at the end is a useful resource to explain the characteristics of each cost curve.
The benefit of using spreadsheets to teach cost curves and cost theories is that students can play with the variables to see how the relationships between costs and output change. I think you can also go further a then model with spreadsheets how profits change when costs change. With the latest updates to Google Spreadsheets and forms you can use these in real-time with student when they are conducting experiments.