The Costs of Production

The Costs of
Production
Chapter 13
Copyright © 2001 by Harcourt, Inc.
All rights reserved. Requests for permission to make copies of any part of the
work should be mailed to:
Permissions Department, Harcourt College Publishers,
6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Firm’s Objective
The economic goal of the firm
is to maximize profits.

A Firm’s Profit
Profit is the firm’s total revenue minus its
total cost.
Profit = Total revenue - Total cost
Total Cost includes all of the
opportunity costs of production

Economic Profit versus
Accounting Profit
Revenue
Total
opportunity
costs
How an Economist
Views a Firm
Explicit
costs
Economic
profit
Implicit
costs
Explicit
costs
Accounting
profit
How an Accountant
Views a Firm
Revenue

What happens to profit though
as you keep on adding
workers?
Additional input
Additional output=Marginal
product

Diminishing Marginal Product
Diminishing marginal product is the
property whereby the marginal product of an
input declines as the quantity of the input
increases.
Example: As more and more workers are
hired at a firm, each additional worker
contributes less and less to production
because the firm has a limited amount of
equipment.

Your Journal Question
 You have just been given 10
acres of land.
 The land is of varying quality.
 The amount of land remains
fixed.
 What will happen to your
yield as you keep on adding
workers?
 Can you write down an
example of diminishing
returns from your
experience?

A Production Function...
Quantity of
Output
(cookies
per hour)
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
Number of Workers Hired0 1 2 3 4 5
Production function

Fixed and Variable Costs
Fixed costs are those costs that do not
vary with the quantity of output
produced.
Variable costs are those costs that do
change as the firm alters the quantity of
output produced.
Short Run vs. Long Run Costs

Family of Total Costs
Total Fixed Costs (TFC)
Total Variable Costs (TVC)
Total Costs (TC)
TC = TFC + TVC

Family of Total Costs
Quantity Total Cost Fixed Cost Variable Cost
0 $ 3.00 $3.00 $ 0.00
1 3.30 3.00 0.30
2 3.80 3.00 0.80
3 4.50 3.00 1.50
4 5.40 3.00 2.40
5 6.50 3.00 3.50
6 7.80 3.00 4.80
7 9.30 3.00 6.30
8 11.00 3.00 8.00
9 12.90 3.00 9.90
10 15.00 3.00 12.00

Total-Cost Curve...
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
0 2 4 6 8 10 12
Quantity of Output
(glasses of lemonade per hour)
TotalCost
Total-cost
curve

 Relation
Between
Production
Function
and Total
Cost.
 Dimininish
ing
Returns

Average Costs
Average costs can be determined by
dividing the firm’s costs by the
quantity of output produced.
The average cost is the cost of each
typical unit of product.

Family of Average Costs
Average Fixed Costs (AFC)
Average Variable Costs (AVC)
Average Total Costs (ATC)
ATC = AFC + AVC

$3.00
Family of Average Costs
Quantity AFC AVC ATC
0 — — —
1 $0.30 $3.30
2 1.50 0.40 1.90
3 1.00 0.50 1.50
4 0.75 0.60 1.35
5 0.60 0.70 1.30
6 0.50 0.80 1.30
7 0.43 0.90 1.33
8 0.38 1.00 1.38
9 0.33 1.10 1.43
10 0.30 1.20 1.50

Marginal Cost
Marginal cost (MC) measures the
amount total cost rises when the firm
increases production by one unit.
Marginal cost helps answer the
following question:
 How much does it cost to produce an
additional unit of output?

Marginal Cost
Q
TC=
quantity)in(Change
cost)totalin(Change
=MC



ATC
AVC
MC
Average-Cost and Marginal-Cost
Curves...
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
0 2 4 6 8 10 12
Quantity of Output
Costs
AFC

MC
ATC
Relationship Between Marginal
Cost and Average Total Cost
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
0 2 4 6 8 10 12
Quantity of Output
Costs

Three Important Properties of
Cost Curves
 Marginal cost eventually rises with the
quantity of output.
Law of Diminishing Marginal Returns
 The average-total-cost curve is U-shaped.
 The marginal-cost curve crosses the average-
total-cost curve at the minimum of average
total cost.
 Work on homework assignment!

Costs in the Long Run
For many firms, the division of total
costs between fixed and variable costs
depends on the time horizon being
considered.
 In the short run some costs are fixed.
 In the long run fixed costs become variable
costs.

Average Total Cost in the Short
and Long Runs...
Quantity of
Cars per Day
0
Average
Total
Cost
ATC in short
run with
small factory
ATC in short
run with
medium factory
ATC in short
run with
large factory
ATC in long run

Economies and Diseconomies
of Scale
Diseconomies
of scale
Quantity of
Cars per Day
0
Average
Total
Cost
ATC in long run
Economies
of scale
Constant Returns
to scale

The Costs of Production

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