Ch. 22: The Costs of Production

1. Ch. 22: The Costs of Production • Economic/Opportunity Cost: Value or worth of any resource used to produce a good from its best alternative use • Payments a firm must make or income a firm must provide to attract the resources it needs from alternative production opportunities • Involves Explicit and Implicit Costs Prof. Ana Corrales ECO 2023 Notes

2. Explicit and Implicit Costs • Explicit costs are payments for the use of resources owned by others • Implicit costs are the opportunity costs of using self-owned, self-employed resources at the value of their best alternative use • Economic costs = Explicit + Implicit Costs Prof. Ana Corrales ECO 2023 Notes

3. Normal and Economic Profits • Economic costs includes Normal Profit (e.g., Entrepreneurial Income) • Economic Profit (or Pure Profit) = Total Revenue – Economic Costs Prof. Ana Corrales ECO 2023 Notes

4. Short-run v. Long-run • Short-run: Period too short for suppliers or producers to alter plant capacity • Can only change intensity of “fixed plant production” • Long-run: Period long enough to change any or all resources needed for production • “Variable plant” production Prof. Ana Corrales ECO 2023 Notes

5. Short-run Production • Total Product (TP) = Total quantity produced • Marginal Product (MP) = Change in TP / Change in Labor • Average Product (AP) = TP / Units of Labor • Measures how productive each unit of labor is • Labor Productivity Prof. Ana Corrales ECO 2023 Notes

6. Law of Diminishing Returns • As successive units of a variable resource are added to a fixed resource, at some point, marginal product from each additional unit of that variable resource will decline • At some point, overcrowding sets in • Assumes all units of labor are of equal quality Prof. Ana Corrales ECO 2023 Notes

7. Short-Run Production Costs • Fixed Costs: Costs which do not change with output • Variable Costs: Costs that change with the level of output • Total Costs = Fixed Costs + Variable Costs at each level of output Prof. Ana Corrales ECO 2023 Notes

8. Average Costs • Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Quantity (Q) • Declines as output increases • Average Variable Cost (AVC) = Total Variable Cost (TVC) / Quantity • Average Total Cost (ATC) = AFC + AVC Prof. Ana Corrales ECO 2023 Notes

9. Marginal Cost • Cost of producing one additional unit of output • MC = ΔTC / ΔQ • Quantifies all the costs incurred in producing the last unit of output • If that last unit of output is not produced, the firm can “save” this cost Prof. Ana Corrales ECO 2023 Notes

10. Figure 22.6 • Note the relationship between MP and AP • Note the relationship between MC and AVC Prof. Ana Corrales ECO 2023 Notes

11. Long-run Production Costs • Unlimited number of short-run ATC curves, one for each output level • The long-run ATC curve is made up of all the short0run ATC curves • Figure 9.8 • U-shaped • Law of Diminishing Returns does not apply in L-R • No fixed resource, all production resources are variable Prof. Ana Corrales ECO 2023 Notes

12. Economies of Scale • Economies of mass production explains downward-sloping L-R ATC curve • Labor Specialization • Managerial Specialization • Efficient Capital • Learning by doing Prof. Ana Corrales ECO 2023 Notes

13. Diseconomies of Scale • It is difficult to control and coordinate a firm’s operations as it becomes a large scale producer • Expansion creates communication and cooperation problems, bureaucracy, hierarchy, and decision-making slows down • Results: Impaired efficiency and rising ATC Prof. Ana Corrales ECO 2023 Notes

14. Constant Returns to Scale • Range over which L-R ATC does not change • Increase in inputs results in a proportionate increase in output Prof. Ana Corrales ECO 2023 Notes

15. Ch. 22 Study Questions • 1 • 3 • 5 • 6 • 11 Prof. Ana Corrales ECO 2023 Notes