The Costs of Production

1. The Costs of Production Chapter 13

2. Key determinant of a firm’s production and pricing decisions Costs

3. Profit = Total Revenue – Total Cost Or Profit = the amount a firm receives for the sale of its output – the market value of the inputs a firm uses in production Costs

4. Total Cost to a firm = explicit costs + implicit costs Total Cost

5. Money payments to non-owners of the firm for factors of production they supply • Money is flowing OUTSIDE of the firm • Labor, materials, fuel, transportation 1. Explicit Costs

6. NO MONEY LEAVING THE FIRM: • Opportunity costs! • EX: Forgone income: what one would have earned had they not started a business • Forgone interest: what money invested in business would have earned elsewhere 2. Implicit Costs

7. Economist: Total Cost = Explicit Costs + Implicit Costs Accountant: Total Cost = Explicit Costs Economists vs. Accountants

8. Economist: Total Cost = Explicit Costs + Implicit Costs Economic Profit = Total Revenue – (Explicit Costs + Implicit Costs) Accountant: Total Cost = Explicit Costs Accounting Profit = Total Revenue – Explicit Costs Economists vs. Accountants

9. Economist: Total Cost = Explicit Costs + Implicit Costs Economic Profit = Total Revenue – (Explicit Costs + Implicit Costs) Accountant: Total Cost = Explicit Costs Accounting Profit = Total Revenue – Explicit Costs Accounting Profit > Economic Profit

10. Farmer Greer gives banjo lessons for $20 an hour. One day, she spends 10 hours planting $100 worth of seed on her farm. • What opportunity cost has she incurred? • What cost would her accountant measure? • If these seeds will yield $200 worth of crops, does Greer earn an accounting profit? • Does she earn an economics profit? Practice

11. Farmer Greer gives banjo lessons for $20 an hour. One day, she spends 10 hours planting $100 worth of seed on her farm. • What opportunity cost has she incurred? $200 • What cost would her accountant measure? $100 • If these seeds will yield $200 worth of crops, does Greer earn an accounting profit? Yes - $100 • Does she earn an economics profit? No – losing $100 Practice

12. Short-Run Production Relationships

13. Looks at a firm’s quantity of output as related to the quantity of input • When we increase a given input, what happens to our total production? • Example: When we add an extra worker we can look at how much our production increased due to that added worker! Production Function

14. Production Function

15. The change that one unit of input causes in our output is our marginal product! If I add one worker to my firm and my output increases by 20, my marginal product for that one worker is 20. Marginal Product

16. A commercial fisherman notices the following relationship between hours spent fishing and the quantity of fish caught: • What is the marginal product of each hour spent fishing? • Use the data to sketch a graph of the fisherman’s production function. Explain its shape. Practice

17. A commercial fisherman notices the following relationship between hours spent fishing and the quantity of fish caught: • What is the marginal product of each hour spent fishing? • Use the data to sketch a graph of the fisherman’s production function. Explain its shape. Practice

18. The change that one unit of input causes in our output is our marginal product! Get to a point where the value of adding an additional input gets smaller and smaller. This is called DIMINISHING MARGINAL PRODUCT! Marginal Product

19. What do you notice about these two curves?

20. They seem to be the opposite of each other!

21. If the curve on the left is the production function…what is the curve on the right?

22. It is the Total Cost Curve!

23. Looks at the relationship between the quantity of output produced and total cost of production. Total Cost Curve

24. If Farmer Zach plants no seeds on his farm, he gets no harvest. • If he plants 1 bag of seeds, he gets 3 bushels of wheat. • If he plants 2 bags, he gets 5 bushels. • If he plants 3 bags, he gets 6 bushels. • A bag of seeds costs $100, and seeds are his only cost. Use these data to graph Zach’s production function and total cost curve. Graph Practice

25. Good news…we are all going into the pizza business! Pizza Time!

26. We will use our fictional business to illustrate the differences between different types of costs firms must pay! Pizza Time!

27. First, let’s brainstorm some explicit costs associated with starting our pizza business. Pizza Time!

28. Which of these costs do not change no matter how many pizzas we make? Pizza Time!

29. Which of these costs do not change no matter how many pizzas we make? These are FIXED COSTS Pizza Time!

30. Which of these costs vary depending on how many pizzas we are making? Pizza Time!

31. Which of these costs vary depending on how many pizzas we are making? These are VARIABLE COSTS. Pizza Time!

32. If we combine our FIXED COSTS + our VARIABLE COSTS…what do we have? OUR TOTAL COSTS! FIXED COSTS + VARIABLE COSTS = TOTAL COSTS Pizza Time!

33. Fill in the blanks in this table about pizza production! Practice with Fixed/Variable Costs

34. Fill in the blanks in this table about pizza production! Practice with Fixed/Variable Costs

35. So now that we have our costs analyzed as pizza producers…we have to decide what to produce. Two questions we might ask to determine this are: • How much does it cost to make a typical pizza? • How much does it cost to increase production of pizzas by one pie? Pizza Time!

36. Let’s look at just the first question: • How much does it cost to make a typical pizza? How could we mathematically get to this number? First we need to look at the total cost of making a certain number of pizzas Then we divide that cost by the quantity of pizzas we are producing Pizza Time!

37. First we need to look at the total cost of making a certain number of pizzas Then we divide that cost by the quantity of pizzas we are producing Example: We are making 10 pizzas and our total cost is $300. Our cost per pizza is $300 / 10 pizzas = $30 We just figured out our Average Total Cost per pizza!

38. Total Cost / Quantity Average Total Cost

39. If Total Cost = Fixed Cost + Variable Cost We can say that: Average Total Cost = ? + ? One Step Further…

40. Average Total Cost = Average Fixed Cost + ? Average Fixed Cost = Fixed Cost / Quantity One Step Further…

41. Average Total Cost = Average Fixed Cost + Average Variable Cost Average Variable Cost = Variable Cost / Quantity One Step Further…

42. Let’s look at our other production question: • How much does it cost to increase production of pizzas by one pie? Pizza Time!

43. Let’s look at our other production question: • How much does it cost to increase production of pizzas by one pie? It might sound like average total cost would tell us this but IT DOES NOT! We need to know what happens to our costs when we increase by one unit more…what does that sound like. Pizza Time!

44. We need to look at marginal cost – the increase in total cost when we add an extra unit of production Marginal Cost

45. Sami owns a painting company with fixed costs of $200 and the following schedule for variable costs: • Calculate average fixed cost, average variable cost and average total cost for each quantity. Practice

46. Practice

47. Extended Practice

48. Extended Practice

49. Describe what each of these would look like as a curve!

50. Cost Curves – Marginal Cost