Chapter 13 The Costs of Production industrial organization the study of how firms decisions about prices and quantities depend on the market conditions they face What are Costs total revenue the amount a firm receives for the sale of its output QxP total cost market value of the inputs a firm used in production profit revenue cost Costs as Opportunity Costs explicit costs input costs that require an outlay of money by the firm implicit costs input costs that do NOT require an outlay of money by the firm total costs of a business is the sum of explicit and implicit costs An important implicit cost of almost every business is the opportunity cost of the financial capital that has been invested in the business Economic Profit vs Accounting Profit economic profit total revenue total costs including explicit implicit accounting profit total revenue explicit cost Production and Costs production function relationship between the quantity of inputs used to make a good and the quantity of output of that good marginal product increase in output that arises from an additional unit of input diminishing marginal product property whereby the marginal product of an input declines as the quantity of the input increases fixed costs costs that do NOT vary with the quantity of output produced variable costs costs that vary with the quantity of output produced Average and Marginal Cost average total cost total cost divided by quantity of output average fixed cost fixed cost divided quantity of output average variable cost variable cost divided by quantity of output marginal cost increase in total cost that arises from an extra unit of production change in total cost change in Q Marginal cost tells us the increase in total cost that arises from producing an additional unit of output Average total cost tells us the cost of a typical unit of output if total cost is divided evenly over all the units produced Cost Curves and their Shapes Rising Marginal Cost Conrad s marginal cost rises with the quantity of output produced When Conrad produces a small quantity of coffee he has few workers and much of his equipment is not used marginal product of an extra worker is large marginal cost of an extra cup of coffee is small When Conrad produces a large quantity of coffee his shop is crowded with workers he can produce more coffee by adding workers when the quantity of coffee produced is already high marginal product of an extra worker is low and marginal cost of an extra cup of coffee is large U Shaped Average Total Cost As output increases AFC declines ATC declines until firm s output reaches 5 cups of coffee per hour when average total cost is 1 30 When the firm produces more than 6 cups per hour the increase in AVC becomes dominant and ATC starts rising efficient scale quantity of output that minimizes average total cost Relationship Between Marginal Cost and Average Total Cost 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 Typical Cost Curves Marginal cost eventually rises with the quantity of output The average total cost curve is U shaped The marginal cost curve crosses the average total cost curve at the minimum of average total cost Costs in the Short Run and in the Long Run The Relationship between Short Run and Long Run Average Total Cost Economies and Diseconomies of Scale economies of scale property whereby long run average total cost falls as the quantity of output increases diseconomies of scale property whereby long run average total cost rises as the quality of output increases constant returns to scale property whereby long run average total cost stays the same as the quantity of output changes Economies of scale often arise because higher production levels allow specialization among workers which permits each worker to become better at a specific task Diseconomies of scale can arise because of coordination problems that are inherent in any large organization
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