Microeconomics
Lecture 13
!

The Costs 	

of Production
Key Terms
total cost	

profit	

explicit costs	

implicit costs	

economic profit	

accounting profit	

production function	
...
Riyadh Pizza Company
Total Cost TC
Total Cost TC
The market value of
all of the inputs a
firm uses in
production
Total Revenue

TR
Total Revenue

TR

Price x Quantity	

!

TR = P x Q
Profit

PR
Profit

PR

Total Revenue minus
Total Cost	

!

PR = TR - TC
Production Function
Production Function
The relationship
between inputs and
outputs
Marginal Product
Marginal Product
Additional output of
a unit of input
Diminishing Marginal
Product
Diminishing Marginal
Product
Marginal product
declines as input
increases
Fixed Costs

FC
Fixed Costs

FC

Costs that do not
vary with output
Variable Costs VC
Variable Costs VC
Costs that do vary
with output
Total Costs TC
Total Costs TC
Fixed costs plus
variable costs	

!

TC = FC + VC
Average Total Costs	

ATC
Average Total Costs	

ATC
Total costs divided
by quantity of output	

ATC = TC ÷ Q
Average Fixed Costs	

AFC
Average Fixed Costs	

AFC
Fixed costs divided
by quantity of output	

AFC = FC ÷ Q
Average Variable Costs	

AVC
Average Variable Costs	

AVC
Variable costs
divided by quantity
of output	

AVC = VC ÷ Q
Marginal Cost

MC
Marginal Cost MC
The increase in total
cost for the next
unit	

MC = ∆TC ÷ ∆Q
Q
0
1
2
3
4
5
6
7
8
9
10
Fixed	

Cost 	

Q FC
0 100
1

100

2

100

3

100

4

100

5

100

6

100

7

100

8

100

9

100

10

100
Fixed	

 Variable	

Cost 	

 Cost	

Q FC
VC
0 100
1

100

20

2

100

39

3

100

59

4

100

84

5

100

120

6

100

160...
Total	

Fixed	

 Variable	

Cost	

Cost 	

 Cost	

TC	

Q FC
VC
FC + VC
0 100
100
1

100

20

120

2

100

39

139

3

100...
Total	

Fixed	

 Variable	

Cost	

Cost 	

 Cost	

TC	

Q FC
VC
FC + VC
0 100
100

Average	

Fixed	

Cost	

AFC	

FC ÷ Q

...
Total	

Fixed	

 Variable	

Cost	

Cost 	

 Cost	

TC	

Q FC
VC
FC + VC
0 100
100

Average	

 Average	

Fixed	

Variable	
...
Total	

Fixed	

 Variable	

Cost	

Cost 	

 Cost	

TC	

Q FC
VC
FC + VC
0 100
100

Average	

 Average	

 Average	

Fixed	
...
Total	

Fixed	

 Variable	

Cost	

Cost 	

 Cost	

TC	

Q FC
VC
FC + VC
0 100
100

Average	

 Average	

 Average	

Margina...
Total Cost Curve
600
570
540
510
480
450
420
390
360
330
300
270
240
210
180
150
120
90
60
30
0
0

1

2

3

4

5

6

7

8
...
Explicit Costs
Explicit Costs
Costs that require
money
Implicit Costs
Implicit Costs
Costs that do not
require money
Accounting Profit
Accounting Profit
Total Revenue minus
explicit costs
Economic Profit
Economic Profit
Total Revenue minus
both explicit costs
and implicit costs
Accounting Profit =	

Total Revenue - 	

Explicit Costs	

100 - 30 = 70

Economic Profit =	

Total Revenue - 	

Explicit Cos...
Efficient Scale
Efficient Scale
The quantity of
output that
minimizes average
total cost
Short Run 	

vs. 	

Long Run
Short-Run
Short-Run
Cannot change a
fixed cost
Long-Run
Long-Run
Can change all costs	

!

All costs become
variable
Economies of Scale
Economies of Scale
Long-run average
costs fall as quantity
of output increases
Diseconomies of Scale
Diseconomies of Scale
Long-run average
costs rise as quantity
of output increases
Constant Returns to
Scale
Constant Returns to
Scale
Long-run average
costs stays the same
as quantity of output
increases
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101 lecture 13

  1. 1. Microeconomics Lecture 13 ! The Costs of Production
  2. 2. Key Terms total cost profit explicit costs implicit costs economic profit accounting profit production function marginal product diminishing marginal product fixed costs variable costs average total costs average fixed costs average variable costs marginal costs efficient scale economies of scale diseconomies of scale constant returns to scale
  3. 3. Riyadh Pizza Company
  4. 4. Total Cost TC
  5. 5. Total Cost TC The market value of all of the inputs a firm uses in production
  6. 6. Total Revenue TR
  7. 7. Total Revenue TR Price x Quantity ! TR = P x Q
  8. 8. Profit PR
  9. 9. Profit PR Total Revenue minus Total Cost ! PR = TR - TC
  10. 10. Production Function
  11. 11. Production Function The relationship between inputs and outputs
  12. 12. Marginal Product
  13. 13. Marginal Product Additional output of a unit of input
  14. 14. Diminishing Marginal Product
  15. 15. Diminishing Marginal Product Marginal product declines as input increases
  16. 16. Fixed Costs FC
  17. 17. Fixed Costs FC Costs that do not vary with output
  18. 18. Variable Costs VC
  19. 19. Variable Costs VC Costs that do vary with output
  20. 20. Total Costs TC
  21. 21. Total Costs TC Fixed costs plus variable costs ! TC = FC + VC
  22. 22. Average Total Costs ATC
  23. 23. Average Total Costs ATC Total costs divided by quantity of output ATC = TC ÷ Q
  24. 24. Average Fixed Costs AFC
  25. 25. Average Fixed Costs AFC Fixed costs divided by quantity of output AFC = FC ÷ Q
  26. 26. Average Variable Costs AVC
  27. 27. Average Variable Costs AVC Variable costs divided by quantity of output AVC = VC ÷ Q
  28. 28. Marginal Cost MC
  29. 29. Marginal Cost MC The increase in total cost for the next unit MC = ∆TC ÷ ∆Q
  30. 30. Q 0 1 2 3 4 5 6 7 8 9 10
  31. 31. Fixed Cost Q FC 0 100 1 100 2 100 3 100 4 100 5 100 6 100 7 100 8 100 9 100 10 100
  32. 32. Fixed Variable Cost Cost Q FC VC 0 100 1 100 20 2 100 39 3 100 59 4 100 84 5 100 120 6 100 160 7 100 212 8 100 270 9 100 340 10 100 420
  33. 33. Total Fixed Variable Cost Cost Cost TC Q FC VC FC + VC 0 100 100 1 100 20 120 2 100 39 139 3 100 59 159 4 100 84 184 5 100 120 220 6 100 160 260 7 100 212 312 8 100 270 370 9 100 340 440 10 100 420 520
  34. 34. Total Fixed Variable Cost Cost Cost TC Q FC VC FC + VC 0 100 100 Average Fixed Cost AFC FC ÷ Q 1 100 20 120 100 2 100 39 139 50 3 100 59 159 33 4 100 84 184 25 5 100 120 220 20 6 100 160 260 17 7 100 212 312 14 8 100 270 370 13 9 100 340 440 11 10 100 420 520 10
  35. 35. Total Fixed Variable Cost Cost Cost TC Q FC VC FC + VC 0 100 100 Average Average Fixed Variable Cost Cost AFC AVC FC ÷ Q VC ÷ Q 1 100 20 120 100 20.0 2 100 39 139 50 19.5 3 100 59 159 33 19.7 4 100 84 184 25 21.0 5 100 120 220 20 24.0 6 100 160 260 17 26.7 7 100 212 312 14 30.3 8 100 270 370 13 33.8 9 100 340 440 11 37.8 10 100 420 520 10 42.0
  36. 36. Total Fixed Variable Cost Cost Cost TC Q FC VC FC + VC 0 100 100 Average Average Average Fixed Variable Total Cost Cost Cost AFC AVC ATC FC ÷ Q VC ÷ Q TC ÷ Q 1 100 20 120 100 20.0 120.0 2 100 39 139 50 19.5 69.5 3 100 59 159 33 19.7 53.0 4 100 84 184 25 21.0 46.0 5 100 120 220 20 24.0 44.0 6 100 160 260 17 26.7 43.3 7 100 212 312 14 30.3 44.6 8 100 270 370 13 33.8 46.3 9 100 340 440 11 37.8 48.9 10 100 420 520 10 42.0 52.0
  37. 37. Total Fixed Variable Cost Cost Cost TC Q FC VC FC + VC 0 100 100 Average Average Average Marginal Fixed Variable Total Cost Cost Cost Cost MC AFC AVC ATC FC ÷ Q VC ÷ Q TC ÷ Q ∆TC ÷ ∆Q 1 100 20 120 100 20.0 120.0 20 2 100 39 139 50 19.5 69.5 19 3 100 59 159 33 19.7 53.0 20 4 100 84 184 25 21.0 46.0 25 5 100 120 220 20 24.0 44.0 36 6 100 160 260 17 26.7 43.3 40 7 100 212 312 14 30.3 44.6 52 8 100 270 370 13 33.8 46.3 58 9 100 340 440 11 37.8 48.9 70 10 100 420 520 10 42.0 52.0 80
  38. 38. Total Cost Curve 600 570 540 510 480 450 420 390 360 330 300 270 240 210 180 150 120 90 60 30 0 0 1 2 3 4 5 6 7 8 9 10
  39. 39. Explicit Costs
  40. 40. Explicit Costs Costs that require money
  41. 41. Implicit Costs
  42. 42. Implicit Costs Costs that do not require money
  43. 43. Accounting Profit
  44. 44. Accounting Profit Total Revenue minus explicit costs
  45. 45. Economic Profit
  46. 46. Economic Profit Total Revenue minus both explicit costs and implicit costs
  47. 47. Accounting Profit = Total Revenue - Explicit Costs 100 - 30 = 70 Economic Profit = Total Revenue - Explicit Costs - Implicit Cost 100 - 30 - 40 = 30 100 75 50 25 0 Accounting Profit Economic Profit
  48. 48. Efficient Scale
  49. 49. Efficient Scale The quantity of output that minimizes average total cost
  50. 50. Short Run vs. Long Run
  51. 51. Short-Run
  52. 52. Short-Run Cannot change a fixed cost
  53. 53. Long-Run
  54. 54. Long-Run Can change all costs ! All costs become variable
  55. 55. Economies of Scale
  56. 56. Economies of Scale Long-run average costs fall as quantity of output increases
  57. 57. Diseconomies of Scale
  58. 58. Diseconomies of Scale Long-run average costs rise as quantity of output increases
  59. 59. Constant Returns to Scale
  60. 60. Constant Returns to Scale Long-run average costs stays the same as quantity of output increases

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