Chapter 13 The Costs of Production

1. Chapter 13The Costs of Production

2. What are Costs? • Economists assume goal of firms is to maximize profit • Profit = Total Revenue – Total Cost • In other words: Amount firm receives for sale of output minus amount that the firm pays to buy inputs • Review – What is TR?

3. Costs as Opportunity Costs • Firm’s costs of production include all opportunity cost of producing output • Explicit costs: require an outlay of $ • Implicit costs: don’t require an outlay of $

4. Economic vs. Accounting Profit Economic Profit: Total Revenue – Opportunity Costs of production (implicit & explicit) Accounting Profit: Total Revenue – Explicit Costs only Accounting Profit is greater than Economic Profit

5. Production & Costs • Production Function: Relationship between quantity of inputs and quantity of output • Marginal Product: increase in the quantity of output obtained by an additional unit of input - How much more can we produce by hiring one more worker?

6. Diminishing Marginal Product • As more workers are hired, each additional worker contributes less to the production

7. Total Cost Curve • As the quantity produced rises, the total cost curve becomes steeper

8. Various Measures of Cost • Total cost is divided into fixed & variable costs • Fixed costs: do not vary with quantity of output produced (incurred even if the firm produces nothing) • Variable costs: Change as the firm alters the quantity of output produced

9. Average & Marginal Cost • Average Total Cost: Total Cost divided by quantity of output • Average Total Cost = Average Fixed Cost + Average Variable Cost • Marginal Cost = Increase in total cost by increasing production by one unit of output

10. Cost Curves & Their Shapes • Putting 4 curves on costs vs. output graph

11. Rising Marginal Cost • Marginal cost rises with quantity of output because of diminishing marginal product • When quantity produced is high – marginal product is low & marginal cost is high

12. U-Shaped Average Total Cost • U-Shaped because AFC declines as output expands and AVC typically increases as output expands; AFC is high when output levels are low. • Bottom of U-shape is quantity that minimizes average total cost, which is called the efficient scale of the firm

13. Marginal Cost vs. ATC • When marginal cost is less than ATC, ATC is falling. • When MC is greater than ATC, ATC is rising • Analogy of your GPA

14. Typical Cost Curves • 3 important properties: • MC eventually rises with quantity of output • ATC curve is U-shaped • MC curve crosses ATC curve at minimum of ATC These curves include implicit & explicit costs

15. Costs in Short Run & Long Run • Some costs are fixed in the short run, but ALL costs are variable in the long run • The long run ATC curve lies along the lowest points of the short run ATC curve because it has more flexibility to deal with changes in production in long run • Still a U-shape but much flatter

16. Economies of Scale • Economies of scale: long-run ATC falls as quantity of output increases (specialization) • Diseconomies of scale: long-run ATC rises as quantity of output increases (coordination problems) • Constant returns to scale: long-run ATC stays the same as quantity of output changes