Chapter 13 The Costs of Production What Are Costs Goal of a firm is to maximize profits Total revenue the amount a firm receives for the sale of its output Total cost the market value of the inputs a firm uses in production o Include opportunity cost things that must be given up to acquire that item o Explicit costs input costs that require an outlay of money by the firm pay for flour pay the workers o Implicit costs input costs that do not require an outlay of money by the firm working at the cookie shop for an hour when she could be working as a programmer making 100 bucks an hour o Explicit costs implicit costs total cost o Economists look at both explicit and implicit while accountants look at explicit o An important implicit cost opportunity cost of the financial capital that has been invested in the business Profit total revenue total cost o Because economists accountants measure cost differently they also o Economic profit total revenue total cost including implicit and measure profit differently explicit costs What motivates the firm o Accounting profit total revenue total explicit cost Usually larger since it ignores implicit costs Production Costs Production decisions in the short run Production function the relationship between quantity of inputs used to make a good and the quantity of output of that good o Slope of the production function measures the marginal product of the worker Marginal product the increase in output that arises from an additional unit of input ex worker 1 makes 50 cookies worker 2 makes 90 cookies therefore the 2nd workers marginal product is 40 cookies o As the number of workers increases the marginal product declines diminishing marginal product the property whereby the marginal product of an input declines as the quantity of the input increases more workers in the kitchen more in each other s way less able to produce cookies As the number of workers increases the marginal product declines and the production function becomes flatter Total cost curve graph showing the relationship between the quantity produced and the total costs gets steeper as the amount produced rises bc there are more workers to pay A firm s total cost reflects its production function The Various Measures of Cost rent Fixed costs costs that do not vary with the quantity of output produced ex Variable costs costs that vary with the quantity of output produced workers salaries cups milk sugar Average total cost total cost divided by the quantity of output sum of average fixed cost average variable cost tells us the cost of the typical unit of output if the total cost is divided evenly over all the units produced Average fixed cost fixed cost divided by the quantity of output Average variable costs variable cost divided by the quantity of output Marginal cost the increase in total cost that arises from an extra unit of production change in total cost change in quantity tells us the increase in total cost that arises from producing an additional unit of output Graphs of average and marginal cost will be useful when analyzing behavior of firms o Marginal cost increasing linear line Marginal cost rises with the quantity of output produced When the quantity of output is already high the marginal product of an extra worker is low and the marginal cost of an extra unit of output is large o Total Cost u shaped Average fixed costs declines as output rises Average variable costs rises as output increases At low levels of output total cost is high b c fixed costs are spread only over a few units of output THEN output increases the fixed cost is spread more evenly so average fixed cost declines rapidly at first then more slowly As a result total cost also declines until a certain point after this point the increase in average variable cost as output increases becomes the dominant force Efficient scale the quantity of output that minimizes average total cost balances average variable costs average fixed costs Whenever marginal cost is less than average total cost average total cost is falling Whenever marginal cost is greater than average total cost average total cost is rising The marginal cost curve crosses the average total cost curve at its minimum where output is low so marginal cost is beneath average total cost curve so average total cost is falling In real life marginal product does not start to fall immediately b c having a group of workers can divide tasks and work more productively than a single worker Costs in the Short Run and in the Long Run Because many decisions are fixed in the short run but variable in the long run a firm s long run cost curves are different from its short term cost curves Long term average total cost is much flatter u shape than the short run average total cost curve all the short term curves lie on or above the long term curve These properties arise bc firms have greater flexibility in the long run Economies of scale the property whereby long run average total cost falls as the quantity of output increases o Often arise bc higher production levels allow specialization ex large number of workers produce large number of cars can reduce costs with assembly line production Diseconomies of scale the property whereby long run average total cost rises as the quantity of output increases o Arise bc of coordination problems the more cars produced the more stretched out management becomes the less effective managers become at keeping costs down Constant returns to scale the property whereby long run average total cost stays the same as the quantity of output changes Long run average total cost is falling at low levels of production bc of increasing specialization and rising at high levels of production bc of increasing coordination problems
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