The document discusses various factors of production including land, labor, capital and entrepreneurship. It then defines different types of costs businesses face such as explicit costs, implicit costs, fixed costs, variable costs, total costs, average costs, marginal costs, accounting profit and economic profit. It provides examples to illustrate the differences between these concepts.

7. Economists versus Accountants How an Economist Views a Firm How an Accountant Views a Firm Revenue Total opportunity costs Revenue Economic profit Implicit costs Explicit costs Explicit costs Accounting profit

12. Total Product Curve

17. Example 1: Farmer Jack’s Production Function 0 0 500 1,000 1,500 2,000 2,500 3,000 0 1 2 3 4 5 No. of workers Quantity of output 3000 5 2800 4 2400 3 1800 2 1000 1 0 0 Q (bushels of wheat) L (no. of workers)

19. EXAMPLE 1: Total & Marginal Product 200 400 600 800 1000 MP L 0 3000 5 2800 4 2400 3 1800 2 1000 1 0 0 Q (bushels of wheat) L (no. of workers) ∆ Q = 1000 ∆ L = 1 ∆ Q = 800 ∆ L = 1 ∆ Q = 600 ∆ L = 1 ∆ Q = 400 ∆ L = 1 ∆ Q = 200 ∆ L = 1

20. EXAMPLE 1: MP L = Slope of Prod Function MP L equals the slope of the production function. Notice that MP L diminishes as L increases. This explains why the production function gets flatter as L increases. 3000 5 200 2800 4 400 2400 3 600 1800 2 800 1000 1 1000 0 0 MP L Q (bushels of wheat) L (no. of workers) 0 0 500 1,000 1,500 2,000 2,500 3,000 0 1 2 3 4 5 No. of workers Quantity of output

25. Law of Variable Proportions

49. Cost-Benefit Analysis in an Advertisement

53. EXAMPLE 1: Farmer Jack’s Costs Total Cost 3000 5 2800 4 2400 3 1800 2 1000 1 0 0 Cost of labor Cost of land Q (bushels of wheat) L (no. of workers) 0 $11,000 $9,000 $7,000 $5,000 $3,000 $1,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000

54. EXAMPLE 1: Farmer Jack’s Total Cost Curve Q (bushels of wheat) Total Cost 0 $1,000 1000 $3,000 1800 $5,000 2400 $7,000 2800 $9,000 3000 $11,000

56. EXAMPLE 1: Total and Marginal Cost $10.00 $5.00 $3.33 $2.50 $2.00 Marginal Cost ( MC ) $11,000 $9,000 $7,000 $5,000 $3,000 $1,000 Total Cost 3000 2800 2400 1800 1000 0 Q (bushels of wheat) ∆ Q = 1000 ∆ TC = $2000 ∆ Q = 800 ∆ TC = $2000 ∆ Q = 600 ∆ TC = $2000 ∆ Q = 400 ∆ TC = $2000 ∆ Q = 200 ∆ TC = $2000

57. EXAMPLE 1: The Marginal Cost Curve MC usually rises as Q rises, as in this example. $11,000 $9,000 $7,000 $5,000 $3,000 $1,000 TC MC 3000 2800 2400 1800 1000 0 Q (bushels of wheat) $10.00 $5.00 $3.33 $2.50 $2.00

60. Example 2: Costs 7 6 5 4 3 2 1 0 TC VC FC Q $0 $100 $200 $300 $400 $500 $600 $700 $800 0 1 2 3 4 5 6 7 Q Costs FC VC TC 0 620 480 380 310 260 220 170 $100 520 380 280 210 160 120 70 $0 100 100 100 100 100 100 100 $100

61. EXAMPLE 2: Marginal Cost Recall, Marginal Cost ( MC ) is the change in total cost from producing one more unit: Usually, MC rises as Q rises, due to diminishing marginal product. Sometimes (as here), MC falls before rising. (In other examples, MC may be constant.) 620 7 480 6 380 5 310 4 260 3 220 2 170 1 $100 0 MC TC Q 140 100 70 50 40 50 $70 ∆ TC ∆ Q MC =

62. EXAMPLE 2: Average Fixed Cost 100 7 100 6 100 5 100 4 100 3 100 2 100 1 $100 0 AFC FC Q Average fixed cost ( AFC ) is the fixed cost per unit of the quantity of output: AFC = FC / Q Notice that AFC falls as Q rises: The firm is spreading its fixed costs over a larger and larger number of units. 0 14.29 16.67 20 25 33.33 50 $100 n.a.

63. EXAMPLE 2: Average Variable Cost 520 7 380 6 280 5 210 4 160 3 120 2 70 1 $0 0 AVC VC Q Average variable cost ( AVC ) is the variable cost per unit of the output: AVC = VC / Q As Q rises, AVC may fall initially. In most cases, AVC will eventually rise as output rises. 0 74.29 63.33 56.00 52.50 53.33 60 $70 n.a.

64. EXAMPLE 2: Average Total Cost [a.k.a. Average Cost] ATC 620 7 480 6 380 5 310 4 260 3 220 2 170 1 $100 0 TC Q 0 Average total cost ( ATC ) is the total cost per unit of the output: ATC = TC / Q Also, ATC = AFC + AVC 88.57 80 76 77.50 86.67 110 $170 n.a. 74.29 14.29 63.33 16.67 56.00 20 52.50 25 53.33 33.33 60 50 $70 $100 n.a. n.a. AVC AFC

65. EXAMPLE 2: Average Total Cost Usually, as in this example, the ATC curve is U-shaped. 88.57 80 76 77.50 86.67 110 $170 n.a. ATC 620 7 480 6 380 5 310 4 260 3 220 2 170 1 $100 0 TC Q 0 $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs

66. EXAMPLE 2: The Various Cost Curves Together 0 AFC AVC ATC MC $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs

69. EXAMPLE 2: Why ATC Is Usually U-Shaped 0 As Q rises: Initially, falling AFC pulls ATC down. Eventually, rising AVC pulls ATC up. $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs

70. EXAMPLE 2: ATC and MC 0 When MC < ATC , ATC is falling. When MC > ATC , ATC is rising. The MC curve crosses the ATC curve at the ATC curve’s minimum. That is, when MC=AC, ATC is at its minimum. ATC MC $0 $25 $50 $75 $100 $125 $150 $175 $200 0 1 2 3 4 5 6 7 Q Costs

72. EXAMPLE 3: LRATC with 3 factory Sizes Firm can choose from 3 factory sizes: S , M , L . Each size has its own SRATC curve. The firm can change to a different factory size in the long run, but not in the short run. ATC S ATC M ATC L Q Avg Total Cost

73. EXAMPLE 3: LRATC with 3 factory Sizes LRATC To produce less than Q A , firm will choose size S in the long run. To produce between Q A and Q B , firm will choose size M in the long run. To produce more than Q B , firm will choose size L in the long run. ATC S ATC M ATC L Q Avg Total Cost Q A Q B

74. A Typical LRATC Curve In the real world, factories come in many sizes, each with its own SRATC curve. So a typical LRATC curve looks like this: Q ATC LRATC

75. How ATC Changes As the Scale of Production Changes Economies of scale : ATC falls as Q increases. Constant returns to scale : ATC stays the same as Q increases. Diseconomies of scale : ATC rises as Q increases. LRATC Q ATC