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- 1. Chapter 13<br />The Cost of Production<br />
- 2. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 2<br />Examine what items are included in a firm’s costs of production.<br />Analyze the link between a firm’s production process and its total costs.<br />Learn the meaning of average total cost and marginal cost and how they are related.<br />Consider the shape of a typical firm’s cost curves.<br />Examine the relationship between short-run and long run costs. <br />In this chapter you will…<br />
- 3. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 3<br />Supplyand demand are the two words that economists use most often.<br />Supplyand demandare the forces that make market economies work.<br />Modern microeconomics is about supply, demand, and market equilibrium.<br />THE COSTS OF PRODUCTION<br />
- 4. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 4<br />According to the Law of Supply:<br />Firms are willing to produce and sell a greater quantity of a good when the price of the good is high.<br />This results in a supply curve that slopes upward.<br />The Firm’s Objective<br />The economic goal of the firm is to maximize profits.<br />THE COSTS OF PRODUCTION<br />
- 5. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 5<br />Total Revenue<br />The amount a firm receives for the sale of its output.<br />Total Cost<br />The market value of the inputs a firm uses in production.<br />Profit <br />The firm’s total revenue minus its total cost.<br />Profit = Total revenue - Total cost<br />Total Revenue, Total Costs, and Profit<br />
- 6. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 6<br />A firm’s cost of production includes all the opportunity costs of making its output of goods and services.<br />Explicit and Implicit Costs<br />A firm’s cost of production include explicit costs and implicit costs.<br />Explicit costs are input costs that require a direct outlay of money by the firm. <br />Implicit costs are input costs that do not require an outlay of money by the firm.<br />Cost as an Opportunity Cost<br />
- 7. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 7<br />Example:<br />Helen uses $300 000 of her savings to buy her cookie factory from the previous owner.<br />If she had left her money in a savings account that pays an interest at a rate of 5 percent, she would have earned $15 000 a year. <br />Helen by buying a cookie factory has foregone $15 000 a year in interest income.<br />This foregone $15 000 is an implicit opportunity cost of Helen’s business. <br />The accountant will not show this cost.<br />Cost as an Opportunity Cost<br />
- 8. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 8<br />Economists measure a firm’s economic profitas total revenue minus total cost, including both explicit and implicit costs.<br />Accountants measure the accounting profitas the firm’s total revenue minus only the firm’s explicit costs. <br />Economic Profit versus Accounting Profit<br />
- 9. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 9<br />When total revenue exceeds both explicit and implicit costs, the firm earns economicprofit.<br />Economic profit is smaller than accounting profit.<br />Economic Profit Versus Accounting Profit<br />
- 10. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 10<br />Revenue<br />Revenue<br />Total Opportunity Costs<br />Figure 13-1: Economists versus Accountants<br />How an Accountant Views a Firm<br />How an Economist Views a Firm<br />Accounting profit<br />Economic profit<br />Implicit costs<br />Explicit costs<br />Explicit costs<br />
- 11. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 11<br />Assumption: The size of Helen’s cookie factory is fixed and the quantity of cookies produced can only vary by changing the number of workers. <br />This assumption is realistic in the short-run but not the long-run.<br />PRODUCTION AND COSTS<br />
- 12. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 12<br />$30<br />$0<br />$30<br />0<br />50<br />40<br />10<br />30<br />50<br />40<br />50<br />20<br />30<br />90<br />30<br />60<br />30<br />30<br />120<br />20<br />70<br />40<br />30<br />140<br />10<br />80<br />50<br />30<br />150<br />Table 13-1: A Production Function and Total Cost: Hungry Helen’s Cookie Factory<br />Total cost of inputs (cost of factory + cost of workers)<br />Cost of worker<br />Cost of factory<br />Marginal product of labour<br />Output (quantity of cookies produced per hour)<br />Number of workers<br />0<br />1<br />2<br />3<br />4<br />5<br />
- 13. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 13<br />The Production Function<br />The production functionshows the relationship between quantity of inputs used to make a good and the quantity of output of that good.<br />Marginal Product<br />The marginal productof any input in the production process is the increase in output that arises from an additional unit of that input.<br />PRODUCTION AND COSTS<br />
- 14. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 14<br />Diminishing Marginal Product<br />Diminishing marginal productis the property whereby the marginal product of an input declines as the quantity of the input increases. <br />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. <br />PRODUCTION AND COSTS<br />
- 15. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 15<br />150<br />140<br />120<br />90<br />50<br />Figure 13-2: Hungry Helen’s Production Function<br />Quantity of Output (cookies per hour)<br />Production function<br />1<br />0<br />4<br />2<br />3<br />5<br />Number of Workers Hired <br />
- 16. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 16<br />Diminishing Marginal Product<br />Diminishing marginal productis the property whereby the marginal product of an input declines as the quantity of the input increases. <br />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. <br />PRODUCTION AND COSTS<br />
- 17. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 17<br />Diminishing Marginal Product<br />The slope of the production function measures the marginal product of an input, such as a worker.<br />When the marginal product declines, the production function becomes flatter.<br />PRODUCTION AND COSTS<br />
- 18. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 18<br />The relationship between the quantity a firm can produce and its costs determines pricing decisions. <br />See last three columns in Table 13-1.<br />The total-cost curve shows this relationship graphically. <br />From the Production Function to the Total-Cost Curve<br />
- 19. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 19<br />$30<br />$0<br />$30<br />0<br />50<br />40<br />10<br />30<br />50<br />40<br />50<br />20<br />30<br />90<br />30<br />60<br />30<br />30<br />120<br />20<br />70<br />40<br />30<br />140<br />10<br />80<br />50<br />30<br />150<br />Table 13-1: A Production Function and Total Cost: Hungry Helen’s Cookie Factory<br />Total cost of inputs (cost of factory + cost of workers)<br />Cost of worker<br />Cost of factory<br />Marginal product of labour<br />Output (quantity of cookies produced per hour)<br />Number of workers<br />0<br />1<br />2<br />3<br />4<br />5<br />
- 20. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 20<br />$80<br />70<br />60<br />50<br />40<br />30<br />50<br />120<br />140<br />150<br />90<br />Figure 13-3: Hungry Helen’s Total-Cost Curve<br />Total Cost <br />Total-cost curve<br />0<br />Quantity of Output (cookies per hour)<br />
- 21. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 21<br />Costs of production may be divided into fixed costsand variable costs.<br />Fixed costs are those costs that do notvary with the quantity of output produced.<br />Variable costs are those costs that do varywith the quantity of output produced.<br />THE VARIOUS MEASURES OF COST<br />
- 22. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 22<br />Total Costs<br />Total Fixed Costs (TFC)<br />Total Variable Costs (TVC)<br />Total Costs (TC) <br />TC = TFC + TVC<br />THE VARIOUS MEASURES OF COST<br />
- 23. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 23<br />Average Costs<br />Average costs can be determined by dividing the firm’s costs by the quantity of output it produces. <br />The average cost is the cost of each typical unit of product. <br />THE VARIOUS MEASURES OF COST<br />
- 24. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 24<br />Average Costs<br />Average Fixed Costs (AFC) <br />= ATC / Q<br />Average Variable Costs (AVC) <br />= AVC / Q<br />Average Total Costs (ATC) <br />= ATC / Q<br />ATC = AFC + AVC<br />THE VARIOUS MEASURES OF COST<br />
- 25. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 25<br />Marginal Cost<br />Marginal cost(MC) measures the increase in total cost that arises from an extra unit of production.<br />Marginal cost helps answer the following question:<br />How much does it cost to produce an additional unit of output?<br />THE VARIOUS MEASURES OF COST<br />
- 26. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 26<br />Marginal Cost<br />Marginal cost(MC) measures the increase in total cost that arises from an extra unit of production.<br />Marginal cost helps answer the following question:<br />How much does it cost to produce an additional unit of output?<br />THE VARIOUS MEASURES OF COST<br />
- 27. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 27<br />---------<br />---------<br />---------<br />$ 0.00<br />$ 3.00<br />$ 3.00<br />0<br />0.30<br />$ 3.30<br />$ 0.30<br /> $ 3.00<br />0.30<br />3.00<br />3.30<br />1<br />0.50<br />1.90<br />0.40<br />1.50<br />0.80<br />3.00<br />3.80<br />2<br />0.70<br />1.50<br />0.50<br />1.00<br />1.50<br />3.00<br />4.50<br />3<br />0.90<br />1.35<br />0.60<br />0.75<br />2.40<br />3.00<br />5.40<br />4<br />1.10<br />1.30<br />0.70<br />0.60<br />3.50<br />3.00<br />6.50<br />5<br />1.30<br />1.30<br />0.80<br />0.50<br />4.80<br />3.00<br />7.80<br />6<br />1.50<br />1.33<br />0.90<br />0.43<br />6.30<br />3.00<br />9.30<br />7<br />1.70<br />1.38<br />1.00<br />0.38<br />8.00<br />3.00<br />11.00<br />8<br />1.90<br />1.43<br />1.10<br />0.33<br />9.90<br />3.00<br />12.90<br />9<br />2.10<br />1.50<br />1.20<br />0.30<br />12.00<br />3.00<br />15.00<br />10<br />Table 13-2: The Various Measures of Cost: Thirsty Thelma’s Lemonade Stand<br />Marginal Cost<br />Average Total Cost<br />Average Variable Cost<br />Average Fixed Cost<br />Variable Cost<br />Fixed Cost<br />Total Cost<br />Quantity of lemonade (Glasses per hour)<br />
- 28. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 28<br />15.00<br />11.00<br />5.40<br />3.00<br />8<br />10<br />0<br />Figure 13-4: Thirsty Thelma’s Total-Cost Curve<br />Total Cost <br />Total-cost curve<br />4<br />Quantity of Output (glasses of lemonade per hour)<br />
- 29. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 29<br />Cost Curves and their Shapes<br />The cost curves shown here for Thirsty Thelma’s Lemonade Stand have some features that are common to the cost curves of many firms in the economy.<br />Lets examine three features in particular:<br />The shape of the marginal cost curve<br />The shape of the average cost curve<br />The relationship between marginal and average total cost<br />
- 30. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 30<br />MC<br />ATC<br />AVC<br />1.30<br />AFC<br />Figure 13-5: Thirsty Thelma’s Average-Cost and Marginal-Cost Curves<br />Costs <br />3.30<br />3.00<br />0<br />5<br />4<br />3<br />2<br />1<br />6<br />10<br />7<br />8<br />9<br />Quantity of Output (glasses of lemonade per hour)<br />
- 31. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 31<br />Marginal cost rises with the amount of output produced.<br />This reflects the property of diminishing marginal product. <br />The average total-cost curve is U-shaped.<br />At very low levels of output average total cost is high because fixed cost is spread over only a few units.<br />Average total cost declines as output increases.<br />Average total cost starts rising because average variable cost rises substantially.<br />Cost Curves and their Shapes<br />
- 32. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 32<br />Cost Curves and their Shapes<br />The bottom of the U-shaped ATC curve occurs at the quantity that minimizes average total cost. This quantity is sometimes called the efficient scaleof the firm.<br />Relationship between Marginal Cost and Average Total Cost<br />Whenever marginal cost is less than average total cost, average total cost is falling.<br />Whenever marginal cost is greater than average total cost, average total cost is rising.<br />The marginal-cost curve crosses the average-total-cost curve at the efficient scale.<br />
- 33. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 33<br />Typical Cost Curves<br />In the previous examples, the firms exhibit diminishing marginal product and, therefore, rising marginal cost at all levels of output. <br />Actual firms are often a bit more complicated than this. E.g., diminishing marginal product does not start after the first worker id hired. <br />Table 13-3 shows such a firm.<br />
- 34. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 34<br />---------<br />---------<br />---------<br />$ 0.00<br />$ 2.00<br />$ 2.00<br />0<br />1.00<br />$ 3.00<br />$ 1.00<br /> $ 2.00<br />1.00<br />2.00<br />3.00<br />1<br />0.80<br />1.90<br />0.90<br />1.00<br />1.80<br />2.00<br />3.80<br />2<br />0.60<br />1.47<br />0.80<br />0.67<br />2.40<br />2.00<br />4.40<br />3<br />0.40<br />1.20<br />0.70<br />0.50<br />2.80<br />2.00<br />5.20<br />4<br />0.40<br />1.04<br />0.64<br />0.40<br />3.20<br />2.00<br />5.80<br />5<br />0.60<br />0.96<br />0.63<br />0.33<br />3.80<br />2.00<br />6.60<br />6<br />0.80<br />0.95<br />0.66<br />0.29<br />4.60<br />2.00<br />7.60<br />7<br />1.00<br />0.98<br />0.70<br />0.25<br />5.60<br />2.00<br />8.80<br />8<br />1.20<br />1.02<br />0.76<br />0.22<br />6.80<br />2.00<br />10.20<br />9<br />1.40<br />1.07<br />0.82<br />0.20<br />8.20<br />2.00<br />11.80<br />10<br />Table 13-3: The Various Measures of Cost: Big Bob’s Bagel Bin<br />Marginal Cost<br />Average Total Cost<br />Average Variable Cost<br />Average Fixed Cost<br />Variable Cost<br />Fixed Cost<br />Total Cost<br />Quantity of lBagels (per hour)<br />
- 35. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 35<br />Figure 13-6a): Big Bob’s Cost Curves<br />(a) Total-Cost Curve<br />Total<br />Cost<br />TC<br />$18.00<br />16.00<br />14.00<br />12.00<br />10.00<br />8.00<br />6.00<br />4.00<br />2.00<br />4<br />2<br />6<br />8<br />14<br />12<br />10<br />0<br />Quantity of Output (bagels per hour)<br />Copyright © 2004 South-Western<br />
- 36. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 36<br />Figure 13-6b): Big Bob’s Cost Curves<br />(b) Marginal- and Average-Cost Curves<br />Costs<br />$3.00<br />2.50<br />MC<br />2.00<br />1.50<br />ATC<br />AVC<br />1.00<br />0.50<br />AFC<br />0<br />4<br />2<br />6<br />8<br />14<br />12<br />10<br />Quantity of Output (bagels per hour)<br />Copyright © 2004 South-Western<br />
- 37. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 37<br />Typical Cost Curves<br />Three Important Properties of Cost Curves<br />Marginal cost eventually rises with the quantity of output.<br />The average-total-cost curve is U-shaped.<br />The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.<br />
- 38. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 38<br />THE RELATIONSHIP BETWEEN THE SHORT RUN AND THE LONG RUN<br />For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.<br />In the short run, some costs are fixed.<br />In the long run, fixed costs become variable costs.<br />Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.<br />
- 39. ATC<br /> in short<br />ATC<br /> in short<br />ATC<br /> in short<br />run with<br />run with<br />run with<br />small factory<br />medium factory<br />large factory<br />ATC<br /> in long run<br />Figure 13-7: Average Total Cost in the Short and Long Runs<br />Average<br />Total<br />Cost<br />$12,000<br />Quantity of<br />0<br />1,200<br />Cars per Day<br />
- 40. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 40<br />Economies and Diseconomies of Scale<br />Economies of scalerefer to the property whereby long-run average total cost falls as the quantity of output increases.<br />Diseconomies of scalerefer to the property whereby long-run average total cost rises as the quantity of output increases.<br />Constant returns to scalerefers to the property whereby long-run average total cost stays the same as the quantity of output increases<br />
- 41. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 41<br />Summary<br /><ul><li>The goal of firms is to maximize profit, which equals total revenue minus total cost.
- 42. When analyzing a firm’s behavior, it is important to include all the opportunity costs of production.
- 43. Some opportunity costs are explicit while other opportunity costs are implicit.</li></li></ul><li>Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 42<br />Summary<br /><ul><li>A firm’s costs reflect its production process.
- 44. A typical firm’s production function gets flatter as the quantity of input increases, displaying the property of diminishing marginal product.</li></li></ul><li>Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 43<br />Summary<br /><ul><li>A firm’s total costs are divided between fixed and variable costs. Fixed costs do not change when the firm alters the quantity of output produced; variable costs do change as the firm alters quantity of output produced.
- 45. Average total cost is total cost divided by the quantity of output.</li></li></ul><li>Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 44<br />Summary<br /><ul><li>Marginal cost is the amount by which total cost would rise if output were increased by one unit.
- 46. The marginal cost always rises with the quantity of output.
- 47. Average cost first falls as output increases and then rises.</li></li></ul><li>Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 45<br />Summary<br /><ul><li>The average-total-cost curve is U-shaped.
- 48. The marginal-cost curve always crosses the average-total-cost curve at the minimum of ATC.
- 49. A firm’s costs often depend on the time horizon being considered.
- 50. In particular, many costs are fixed in the short run but variable in the long run.</li></li></ul><li>Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition<br />Chapter 13: Page 46<br />The End<br />

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