Costs of Production Chapter 13 (Week 10)Key Assumption: Profit MaximizationTotal Cost: all opportunity costsEconomists vs. AccountantsProduction FunctionSlide 6From the Production Function to the Total-Cost CurvePowerPoint PresentationCalculating Total CostTotal-Cost CurveSlide 11Five Different Cost CurvesCalculating Marginal CostThirsty Thelma’s Total-Cost CurveFigure 5 Thirsty Thelma’s Average-Cost and Marginal-Cost CurvesReturns to Scale (RTS)Adam Smith in the Pin FactoryIncreasing and then Decreasing RTSFigure 6 Big Bob’s Cost CurvesShort and Long RunsFigure 7 Average Total Cost in the Short and Long RunCosts of ProductionChapter 13 (Week 10)Key Assumption: Profit MaximizationProfit = Total Revenue – Total CostTotal Cost: all opportunity costsExplicit vs. ImplicitExamples of implicit costs: income that could have been earned by firm’s owner, investment return that could have been made on money put into the firm.Economists vs. AccountantsCopyright © 2004 South-WesternRevenueTotalopportunitycostsHow an EconomistViews a FirmHow an AccountantViews a FirmRevenueEconomicprofitImplicitcostsExplicitcostsExplicitcostsAccountingprofitProduction FunctionWorkers (L) Output (Q)Marginal Product (dQ/ dL)0 0 01 50 502 90 403 120 304 140 205 150 10Production FunctionFrom the Production Function to the Total-Cost CurveFor total cost curve, quantity is marked along the horizontal axis and total cost is marked along the vertical.For every quantity, calculate the total cost. Total Cost = Fixed Cost + Variable Cost Fixed Cost: cost of setting up the business (plant & equipment), fixed costs are the same regardless of the quantity produced. Variable Cost: labor and raw materials that can be varied with the scale of operation.Calculating Total CostL Q FC VC TC0 0 30 0 301 50 30 10 402 90 30 20 503 120 30 30 604 140 30 40 705 150 30 50 80Total-Cost CurveHours Quantity of Fish0 01 102 183 244 285 30The following table shows a fisherman’s output. Calculate the marginal product for each hour worked. Does he experience diminishing returns? Suppose the opportunity cost of his time is $5/hour and his fixed cost is $10. Graph his total cost function.Five Different Cost Curves1. Total Cost (TC)2. Average Total Cost (ATC = TC/Q)3. Average Fixed Cost (AFC = FC/Q)4. Average Variable Cost (AVC = VC/Q)5. Marginal Cost (MC = TC/ Q)Calculating Marginal CostQ TC MC0 3.00 ---1 3.30 0.302 3.80 0.503 4.50 0.704 5.40 0.905 6.50 1.106 7.80 1.307 9.30 1.508 11.00 1.709 12.90 1.9010 15.00 2.10Thirsty Thelma’s Total-Cost CurveFigure 5 Thirsty Thelma’s Average-Cost and Marginal-Cost CurvesCopyright © 2004 South-WesternCosts$3.503.253.002.752.502.252.001.751.501.251.000.750.500.25Quantityof Output(glasses of lemonade per hour)0 1 432 765 98 10MCATCAVCAFCReturns to Scale (RTS) Diminishing (all examples so far) Increasing  ConstantAdam Smith in the Pin FactoryOne man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on is a peculiar business; to whiten it is another; it is even a trade by itself to put them into paper.… they certainly could not each of them make twenty, perhaps not one pin a day. –AS, 1776Increasing and then Decreasing RTSFigure 6 Big Bob’s Cost CurvesCopyright © 2004 South-Western(b) Marginal- and Average-Cost CurvesQuantity of Output (bagels per hour)Costs$3.002.502.001.501.000.500 42 6 8 141210MCATCAVCAFCShort and Long RunsShort: plant & equipment fixed.Long: time enough for plant & equipment to be adjustedFigure 7 Average Total Cost in the Short and Long RunCopyright © 2004 South-WesternQuantity ofCars per Day0AverageTotalCost1,200$12,0001,00010,000EconomiesofscaleATC in shortrun withsmall factoryATC in shortrun withmedium factoryATC in shortrun withlarge factoryATC in long runDiseconomiesofscaleConstantreturns