lec - 1 - chapter 13 - the costs of production

7/31/2019 Lec - 1 - Chapter 13 - The Costs of Production

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The Costs ofProduction

Chapter 13

Copyright 2001 by Harcourt, Inc .

All rights reserved. Requests for permission to make copies of any part of thework should be mailed to:

Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.


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Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

The Costs of Production

The Law of Supply:

Firms are willing to produce andsell a greater quantity of a good whenthe price of the good is high.

This results in a supply curve thatslopes upward.


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The Firms Objective

The economic goal of the firmis to maximize profits.


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A Firms Total Revenue andTotal Cost

Total RevenueThe amount that the firm receives forthe sale of its output.

Total CostThe amount that the firm pays to buyinputs.


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A Firms Profit

Profit is the firms total revenue minus

its total cost.

Profit = Total revenue - Total cost


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Costs as Opportunity Costs

A firms cost of productionincludes all the opportunitycosts of making its output of

goods and services.


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Explicit and Implicit Costs

A firms cost of production include

explicit costs and implicit costs.Explicit costs involve a direct money

outlay for factors of production.

Implicit costs do not involve a directmoney outlay.


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Economic Profit versusAccounting Profit

Economists measure a firms economicprofit as total revenue minus all the

opportunity costs (explicit and implicit).Accountants measure the accountingprofit as the firms total revenue minus

only the firms explicit costs. In otherwords, they ignore the implicit costs.


9/68Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.


When total revenue exceeds bothexplicit and implicit costs, the firmearns economic profit.

Economic profit is smaller thanaccounting profit.




RevenueTotal

opportunitycosts

How an Economist Views a Firm

Explicitcosts

Economicprofit

Implicitcosts

Explicitcosts

Accountingprofit

How an Accountant Views a Firm

Revenue



A Production Function andTotal Cost

Number of Workers

Output MarginalProduct of

Labor

Cost of Factory

Cost of Workers

Total Cost of Inputs

0 0 $30 $0 $301 50 50 30 10 40

2 90 40 30 20 50

3 120 30 30 30 60

4 140 20 30 40 705 150 10 30 50 80



The Production Function

The production function showsthe relationship between quantityof inputs used to make a good and

the quantity of output of thatgood.



Marginal Product

The marginal product of any input

in the production process is theincrease in the quantity of outputobtained from an additional unit of

that input.



Marginal Product

Additional input Additional output

= Marginalproduct



Diminishing Marginal Product

Diminishing marginal product is theproperty whereby the marginal product of aninput declines as the quantity of the inputincreases.

Example: As more and more workers arehired at a firm, each additional workercontributes less and less to productionbecause the firm has a limited amount of equipment.



A Production Function... Quantity of

Output (cookies

per hour)150140130120110100

908070605040302010

Number of Workers Hired 0 1 2 3 4 5

Production function



Diminishing Marginal Product

The slope of the productionfunction measures the marginalproduct of an input, such as aworker.

When the marginal productdeclines, the production functionbecomes flatter.



From the Production Function tothe Total-Cost Curve

The relationship between the

quantity a firm can produce and itscosts determines pricing decisions.The total-cost curve shows this

relationship graphically.



A Production Function andTotal Cost

Number of Workers

Output MarginalProduct of

Labor

Cost of Factory

Cost of Workers

Total Cost of Inputs

0 0 $30 $0 $301 50 50 30 10 40

2 90 40 30 20 50

3 120 30 30 30 60

4 140 20 30 40 705 150 10 30 50 80

Hungry Helens Cookie Factory



Total-Cost Curve...

TotalCost

$80

70

60

50

40

3020

10

Quantity of Output(cookies per hour)

0 20 40 1401201008060

Total-costcurve



The Various Measures of Cost

Costs of production may bedivided into fixed costs andvariable costs.



Fixed and Variable Costs

Fixed costs are those costs that do not vary with the quantity of outputproduced.Variable costs are those costs that do

change as the firm alters thequantity of output produced.



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 $ 0.001 3.30 3.00 0.302 3.80 3.00 0.803 4.50 3.00 1.504 5.40 3.00 2.405 6.50 3.00 3.50

6 7.80 3.00 4.807 9.30 3.00 6.308 11.00 3.00 8.009 12.90 3.00 9.90

10 15.00 3.00 12.00



Average Costs

Average costs can be determined bydividing the firms costs by thequantity 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




AFC = Fixed cost Quantity

= FC Q

AVC = Variable cost

Quantity =

VC Q

ATC = Total cost Quantity

= TC Q

AFC = Fixed cost Quantity

= FC Q

AVC = Variable cost

Quantity =

VC Q

ATC = Total cost Quantity

= TC Q



$3.00


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


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Marginal Cost

Marginal cost (MC) measures theamount total cost rises when the firm

increases production by one unit.Marginal cost helps answer thefollowing question:

How much does it cost to produce anadditional unit of output?


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Marginal Cost

QTC=

quantity)in(Change

cost)totalin(Change=MC


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Marginal Cost

Quantity TotalCost

MarginalCost

Quantity TotalCost

MarginalCost

0 $3.00 1 3.30 $0.30 6 $7.80 $1.302 3.80 0.50 7 9.30 1.503 4.50 0.70 8 11.00 1.704 5.40 0.90 9 12.90 1.905 6.50 1.10 10 15.00 2.10


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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)

T o

t a

l C o s

t

Total-costcurve


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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


C o s

t s

AFC


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Cost Curves and Their Shapes

Marginal cost rises with the

amount of output produced.This reflects the property of

diminishing marginal product .


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$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

0 2 4 6 8 10 12


C o s

t s

MC


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The average total-cost curve is U-shaped.At very low levels of output average total cost ishigh because fixed cost is spread over only a fewunits.Average total cost declines as output increases.

Average total cost starts rising because averagevariable cost rises substantially.


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The bottom of the U-shape occurs atthe quantity that minimizes average

total cost . This quantity issometimes called the efficient scale of the firm.


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$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

0 2 4 6 8 10 12


T o

t a

l C o s t s

ATC


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Relationship Between MarginalCost and Average Total Cost

Whenever marginal cost is less thanaverage total cost, average total costis falling.Whenever marginal cost is greaterthan average total cost, averagetotal cost is rising.


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Relationship Between Marginal

Cost and Average Total Cost

The marginal-cost curve crossesthe average-total-cost curve atthe efficient scale.

Efficient scale is the quantitythat minimizes average total cost.


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MC

ATC


$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

0 2 4 6 8 10 12


C o s

t s


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The Various Measures of Cost

It is now time to examine therelationships that exist between the

different measures of cost.


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The Various Measures of CostBig Bobs Bagel Bin

Quantityof Bagels

TotalCost

FixedCost

VariableCost

AverageFixedCost

Average Variable

Cost

AverageTotalCost

MarginalCost

0 $2.00 $2.00 $0.001 $3.00 $2.00 $1.00 $2.00 $1.00 $3.00 $1.00

2 $3.80 $2.00 $1.80 $1.00 $0.90 $1.90 $0.803 $4.40 $2.00 $2.40 $0.67 $0.80 $1.47 $0.604 $4.80 $2.00 $2.80 $0.50 $0.70 $1.20 $0.405 $5.20 $2.00 $3.20 $0.40 $0.64 $1.04 $0.406 $5.80 $2.00 $3.80 $0.33 $0.63 $0.97 $0.607 $6.60 $2.00 $4.60 $0.29 $0.66 $0.94 $0.80

8 $7.60 $2.00 $5.60 $0.25 $0.70 $0.95 $1.009 $8.80 $2.00 $6.80 $0.22 $0.76 $0.98 $1.20

10 $10.20 $2.00 $8.20 $0.20 $0.82 $1.02 $1.4011 $11.80 $2.00 $9.80 $0.18 $0.89 $1.07 $1.6012 $13.60 $2.00 $11.60 $0.17 $0.97 $1.13 $1.8013 $15.60 $2.00 $13.60 $0.15 $1.05 $1.20 $2.00

14 $17.80 $2.00 $15.80 $0.14 $1.13 $1.27 $2.20


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Big Bobs Cost Curves...

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

$18.00

$20.00

0 2 4 6 8 10 12 14 16

Quantity of Output

(bagels per hour)

T o

t a l C o s

t

Total Cost Curve


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AFC

AVC

MC


0

0.5

1

1.5

2

2.5

3

3.5

0 2 4 6 8 10 12 14 16 Quantity of Output

C o s

t s

ATC


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Three Important Properties ofCost Curves

Marginal cost eventually rises withthe quantity of output.

The average-total-cost curve is U-shaped.The marginal-cost curve crossesthe average-total-cost curve at theminimum of average total cost.


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Costs in the Long Run

For many firms, the division of totalcosts between fixed and variable costs

depends on the time horizon beingconsidered.

In the short run some costs are fixed.

In the long run fixed costs become variablecosts.


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Costs in the Long Run

Because many costs are fixed inthe short run but variable in thelong run, a firms long -run costcurves differ from its short-runcost curves.


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Average Total Cost in the Short and Long Runs...

Quantity of Cars per Day0

AverageTotalCost

ATC in shortrun with

small factory


medium factory


large factory

ATC in long run


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Economies and Diseconomiesof Scale

Economies of scale occur when long-runaverage total cost declines as outputincreases.Diseconomies of scale occur when long-run average total cost rises as outputincreases.Constant returns to scale occur whenlong-run average total cost does notvary as output increases.


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Diseconomiesof scale

Quantity of Cars per Day

0

AverageTotalCost

ATC in long run

Economiesof scale

Constant Returnsto scale


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Summary

The goal of firms is to maximize profit,which equals total revenue minus totalcost.

When analyzing a firms behavior, it isimportant to include all theopportunity costs of production.

Some opportunity costs are explicitwhile other opportunity costs are

implicit.


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Summary

A firms costs reflect its productionprocess.

A typical firms production function gets

flatter as the quantity of input increases,displaying the property of diminishingmarginal product.

A firms total costs are divided betweenfixed and variable costs. Fixed costs dontvary with quantities produced; variable

costs do.


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Summary

Average total cost is total costdivided by the quantity of output.Marginal cost is the amount bywhich total cost would rise if outputwere increased by one unit.

The marginal cost always rises withthe quantity of output.


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Summary

The average-total-cost curve is U-shaped.The marginal-cost curve alwayscrosses the average-total-cost curveat the minimum of ATC.

A firms costs often depend on thetime horizon being considered.


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GraphicalReview


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RevenueTotalopportunitycosts

How an Economist Views a Firm

Explicitcosts

Economicprofit

Implicitcosts

Explicitcosts

Accountingprofit

How an Accountant Views a Firm

Revenue


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A Production Function...

Quantity of Output

(cookies per hour)

150140130120110100

908070

605040302010

Number of Workers Hired 0 1 2 3 4 5

Production function


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Total-Cost Curve...

TotalCost

$80

70

60

50

40

30

20

10

Quantity of Output(cookies per hour)

0 20 40 1401201008060

Total-costcurve

T l C C


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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)

T o

t a l C

o s

t

Total-costcurve


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Average-Cost and Marginal-Cost Curves...

ATC AVC

MC

$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


C o s

t s

AFC


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$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

0 2 4 6 8 10 12

Quantity of Output


C o s

t s

MC


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$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


T o

t a

l C o s

t s

ATC


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MC

ATC

$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


C o s

t s


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$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

$18.00

$20.00

0 2 4 6 8 10 12 14 16

Quantity of Output

(bagels per hour)

T o

t a l C o s

t

Total Cost Curve


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AFC

AVC

MC

0

0.5

1

1.5

2

2.5

3

3.5

0 2 4 6 8 10 12 14 16 Quantity of Output

C o s

t s

ATC


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Average Total Cost in the Short and Long Runs...

Quantity of Cars per Day0

AverageTotalCost


small factory


medium factory


large factory

ATC in long run

E i d Di i


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Diseconomiesof scale

Quantity of 0

AverageTotalCost

ATC in long run

Economiesof scale

Constant Returnsto scale

lec - 1 - chapter 13 - the costs of production

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