Chapter 13: The Costs of ProductionWhat Are Costs?- Total Revenue, Total Cost, and Profito Ex. Caroline’s Cookie Factoryo Total revenue: The amount a firm receives for the sale of its output (cookies)o Total cost: The market value of the inputs a firm uses in production (flour, sugar, workers, ovens, etc)o Profit: Total revenue minus total costo Caroline’s objective: make firm’s profit as large as possible aka maximize profit- Costs as Opportunity Costso *Recall: Cost of something is what you give up to get it Opportunity cost of an item refers to all things that mustbe forgone to acquire that itemo Explicit costs: input costs that require an outlay of money by the firm (Ex. Wages the firm pays its workers)o Implicit costs: input costs that do not require an outlay of money by the firm (Ex. Wages the firm owner gives up by working in the firm rather than taking another job)o When analyzing a firm’s behavior it is important to include both kinds of costs of production- The Cost of Capital as an Opportunity Costo An important implicit cost of almost every business is opportunity cost of financial capital that has been invested in the business.o Ex. Suppose Caroline used $350,000 of her savings to buy her cookie factory from its previous owner. If Caroline had instead left this money deposited in a savings account that pays an interest rate of 5 percent, she would have earned $15,000 a year in interest income. This forgone $15,000 is one of the implicit opportunity costs of Caroline’s business- Economic Profit versus Accounting Profito Economic profit: total revenue minus total cost, including both explicit and implicit costso Accounting profit: total revenue minus explicit costProduction and Costs- The Production Functiono The relationship between quantity of inputs used to make a good and the quantity of output of that goodNumber of WorkersOutput (quantity ofcookies produced per hourMarginal Product of LaborCost of FactoryCost of WorkersTotal Cost of Inputs (cost of factory + cost of workers)0 050$30 $0 $301 504030 10 402 903030 20 503 1202030 30 604 1401030 50 805 155 30 60 90o Marginal product: the increase in output that arises from an additional unit of inputo Diminishing marginal product: the property whereby the marginal product of an input declines as the quantity of the input increases- From the Production Function to the Total-Cost Curveo A firm’s costs reflect its production process. A typical firm’s production function gets flatter as the quantity of an input increases, displaying the property of diminishing marginal product. o As a result, a firm’s total cost curve gets steeper as the quantityproduced rises.The Various Measures of Cost- Fixed and Variable Costso Fixed costs: costs that do not vary with the quantity of output produced (Ex. Salary)o Variable costs: Costs that vary with the quantity of output produced (Ex. Cost of supplies needed)- Average and Marginal Costo Average total cost: total cost divided by the quantity of outputo Average fixed cost: fixed cost divided by the quantity of outputo Average variable cost: variable cost divided by the quantity of outputo Marginal cost: the increase in total cost that arises from an extra unit of productiono Average cost tells us the cost of a typical unit of output if total cost is divided evenly over all the units produced.o Marginal cost tells us the increase in total cost that arises from producing an additional unit of output- Cost Curves and Their Shapeso Rising Marginal Cost If marginal cost rises with quantity of output produced, reflects property of diminishing marginal product. When quantity of an item being produced is already high, the marginal product of an extra worker is low, and the marginal cost of an extra of that item is largeo U-Shaped Average Total Cost Reflects shapes of both average fixed cost and average variable cost Average fixed cost always declines as output rises because fixed cost is spread over large # of units Average variable cost typically rises as output increases because of diminishing marginal product Bottom of U-shape occurs @ quantity that maximizes average total cost aka the efficient scaleo 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 cost, average total cost is rising Marginal-cost curve crosses average-total-cost curve at its minimumCosts in the Short Run and in the Long Run- Relationship between Short-Run and Long-Run Average Total Costo Because many decisions are fixed in the short run but variable in the long run, a firm’s long-run cost curve differs from its short-run cost curveso Long-run-average-total-cost curve is a much flatter U shape than the short-run average-total-cost curve. o All short-run curves lie on or above the long-run curve- Economies and Diseconomies of Scaleo Economies of scale: the property whereby long-run average total cost falls as the quantity of output increaseso Diseconomies of scale: the property whereby long-run average total cost rises as the quantity of output increaseso Constant returns to scale: the property whereby long-run average total cost stays the same as the quantity of output changeso Cause of economies of scale Specialization: specialization among workers permits each worker to become better at a specific tasko Cause of diseconomies of scale Coordination problems: happens in large
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