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) - Average total cost tells us the cost of a typical unit of output if total cost is 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 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
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