Chapter 13: The Costs of Production1. What are Costs?a) Total Revenue, Total Cost, and Profit- Assumed goal of all firms is to maximize profit-Profit = total revenue – total costo Total revenue = the amount a firm receives for the sale of its outputo Total cost = the market value of the inputs a firm uses in productionb) Costs as Opportunity Costs- Economists consider opportunity costs to include explicit and implicit costso Explicit : input costs that require an outlay of money by the firm- ex: wages, money to buy an input, etc.o Implicit : input costs that do not require an outlay of money by the firms- ex: money someone could be making at a different job- Total cost = explicit costs + implicit costsc) The Cost of Capital as an Opportunity Cost- An important implicit cost of almost any business is the opportunity cost of the financial capital that has been invested in the business.o ex: If you invest $300,000 into a business but could have put that money in savings, and gotten $15,000 in interest, this amount is considered an implicit cost.d) Economic Profit vs. Accounting Profit- Economic profit : total revenue – total cost (explicit + implicit costs)- Accounting profit : total revenue – explicit costEconomic ProfitExplicit CostsExplicit CostsAccounting ProfitImplicit CostsRevenue RevenueTotalOpportunityCosts2. Production and Costsa) The Production Function- Production Function : the relationship between the quantity of inputs used to make a good and the quantity of output of that good. - Marginal Product : the increase in output that arises from an additional unit of inputo As the number of workers increase, marginal product decreases- Diminishing Marginal Product : the property whereby the marginal product of an input declines as the quantity of the input increases.o Graph gets flatter as the number of inputs (workers) increaseo In terms of slope, as the number of workers increases, the marginal product declines, and the production function becomes flatter (curve starts out with steep slopes but as more workers areadded, the slope becomes flatter and flatter as it increases)b) From the Production Function to the Total-Cost Curve- Production function: relatively flat because as the number of workers increases, it becomes crowded, less is produced (diminish marginal produced).- Total-cost curve: when the quantity produced is large, total-cost curve is relatively steep.o Gets steeper as the amount produced rises3. The Various Measures of Costa) Fixed and Variable Costs- Fixed Cost : costs that do not vary with the quantity of output producedo ex: rent, bookkeeper (not affected by quantity sold)- Variable Cost : costs that vary with the quantity of output producedo ex: cost of inputs (more coffee sold, more coffee beans needed to be bought)- Total cost = Fixed costs + Variable Costsb) Average and Marginal Cost- Average Total Cost : total cost divided by quantity of outputo Total cost = sum of fixed cost and variable costo Average fixed cost: fixed cost / quantity of outputo Average variable cost: variable cost / quantity of outputo ATC Tells us the cost of the typical unit, but it does not tell us how much total cost will change asthe firm alters its level of production.- Marginal Cost : the increase in total cost that arises from an extra unity of productiono MC = TC / Q- Average total cost tells us the cost of a typical unit of output if total cost id divided evenly over all the units produced.- Marginal cost tells us the increase in total cost that arises from producing an additional unit of output.c) Typical Cost Curves- Efficient scale: the quantity of output that minimizes average total cost (U-shaped curve)- 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 because at low levels of output, marginal cost is below average total cost, so average total cost is falling. But after the two curvescross, marginal cost rises above average total cost.- Marginal cost eventually rises with the quantity of output4. Costs in the Short Run and in the Long Runa) The Relationship between Short-Run and Long-Run Average Total Cost- Because many decisions 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. - LR ATC curve is much flatter U-shaped that the SR ATC curve. o Due to the greater flexibility firms have in the long run.b) Economies and Diseconomies of Scale- Economies of Scale : the property whereby long-run average total cost falls as the quantity of output increases.o Often arise because higher production levels allow specialization among workers, which permits each worker to become better at a specific task. - Diseconomies of Scale : the property whereby long-run average total cost rises as the quantity of output increases.o Often arise because of coordination problems that are inherent in any large organization. - Constant returns to scale : the property whereby long-run average total cost stays the same as the quantity of output changes.5. ConclusionTerm Definition Mathematical DescriptionExplicit Costs Costs that require an outlay of money by the firmImplicit Costs Costs that do not require an outlay of money by the firmFixed Costs Costs that do not vary with the quantity of output produced FCVariable Costs Costs that vary with the quantity of output produced VCTotal Costs The market value of all the inputs that a firm uses in production TC = FC + VCAverage Fixed Costs Fixed cost divided by the quantity of output AFC = FC / QAverage Variable Costs Variable cost divided by the quantity of output AVC = VC / QAverage Total Costs Total cost divided by quantity of outputs ATC = TC / QMarginal CostsThe increase in total cost that arises from an extra unit ofproductionMC = TC / Q6. Summary- The goal of firms is to maximize profit, which equals total revenue minus total cost.- When analyzing a firm’s behavior, it is important to include all the opportunity costs of production. Some of the opportunity costs, such as the wages a firm pays its workers, are explicit. Other opportunity costs, such as the wages the firm owner gives up by working in the firm rather than taking another job, are implicit. Economic profit takes both explicit and implicit costs into