Lecture Principles of microeconomics - Chapter 13: The costs of production

In this chapter you will: Examine what items are included in a firm’s costs of production, analyze the link between a firm’s production process and its total costs, learn the meaning of average total cost and marginal cost and how they are related, consider the shape of a typical firm’s cost curves, examine the relationship between short-run and long-run costs.

The Firm’s Objective

The economic goal of the firm

is to maximize profits.

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 

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 Hired

0 1 2 3 4 5

Production function

Fixed and Variable Costs

vary with the quantity of output  produced.

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

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

Family of Average Costs

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?

in  

(Change

cost)  

total  

in  

(Change

= MC

∆

∆

AT C AVC MC

Average-Cost and Marginal-Cost Curves

AT C

Relationship Between Marginal Cost and Average Total Cost

Three Important Properties of

Cost Curves

Marginal cost eventually rises with the  quantity of output.

Law of Diminishing Marginal Returns The average­total­cost curve is U­shaped.

The marginal­cost curve crosses the average­ total­cost 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

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