Cost of Produc

The Costs of
Production
Chapter 13
Copyright 2001 by Harcourt, Inc.
All rights reserved. Requests for permission to make copies of any part of the
work should be mailed to:
Permissions Department, Harcourt College Publishers,
6277 Sea Harbor Drive, Orlando, Florida 32887-6777.
The Firms Objective

The economic goal of the firm
is to maximize profits.
Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.
A Firms Profit
Profit is the firms total revenue minus its
total cost.
Profit = Total revenue - Total cost
Total Cost includes all of the

opportunity costs of production
Economic Profit versus

Accounting Profit
How an Economist
Views a Firm
How an Accountant
Views a Firm
Economic
profit
Accounting
profit
Revenue
Implicit
costs
Explicit
costs
Revenue
Total
opportunity
costs
Explicit
costs
What happens to profit though

as you keep on adding
workers?
Marginal =
product
Additional output
Additional input
Diminishing Marginal Product

Diminishing
marginal product is the

property whereby the marginal product of an
input declines as the quantity of the input
increases.
Example: As more and more workers are
hired at a firm, each additional worker
contributes less and less to production
because the firm has a limited amount of
equipment.
Your Journal Question
You have just been given 10

acres of land.
The land is of varying quality.
The amount of land remains
fixed.
What will happen to your
yield as you keep on adding
workers?
Can you write down an
example of diminishing
returns from your
experience?
A Production Function...
Quantity of
Output
(cookies
per hour)
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
Production function
5 Number of Workers Hired
Fixed and Variable Costs

Fixed
costs are those costs that do not

vary with the quantity of output
produced.
Variable costs are those costs that do
change as the firm alters the quantity of
output produced.
Short Run vs. Long Run Costs
Family of Total Costs

Total
Fixed Costs (TFC)

Total Variable Costs (TVC)
Total Costs (TC)
TC = TFC + TVC
Family of Total Costs

Quantity
0
1
2
3
4
5
6
7
8
9
10
Total Cost
Fixed Cost
$ 3.00
3.30
3.80
4.50
5.40
6.50
7.80
9.30
11.00
12.90
15.00
$3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
Variable Cost
$ 0.00
0.30
0.80
1.50
2.40
3.50
4.80
6.30
8.00
9.90
12.00
Total-Cost Curve...
$16.00
Total-cost
curve
$14.00
Total Cost
$12.00
$10.00
$8.00
$6.00
$4.00
$2.00
$0.00
Quantity of Output
(glasses of lemonade per hour)
10
12
Relation
Between
Production
Function
and Total
Cost.
Dimininish
ing
Returns
Average Costs
Average
costs can be determined by

dividing the firms costs by the
quantity of output produced.
The average cost is the cost of each
typical unit of product.
Family of Average Costs

Average
Fixed Costs (AFC)

Average Variable Costs (AVC)
Average Total Costs (ATC)
ATC = AFC + AVC
Family of Average Costs

Quantity
0
1
2
3
4
5
6
7
8
9
10
AFC
AVC
ATC
$3.00
1.50
1.00
0.75
0.60
0.50
0.43
0.38
0.33
0.30
$0.30
0.40
0.50
0.60
0.70
0.80
0.90
1.00
1.10
1.20
$3.30
1.90
1.50
1.35
1.30
1.30
1.33
1.38
1.43
1.50
Marginal Cost
Marginal
cost (MC) measures the

amount total cost rises when the firm
increases production by one unit.
Marginal cost helps answer the
following question:
How
much does it cost to produce an

additional unit of output?
Marginal Cost
(Change in total cost)
MC =
(Change in quantity)
= TC
Average-Cost and Marginal-Cost

Curves...
$3.50
$3.00
Costs
$2.50
MC
$2.00
ATC
AVC
$1.50
$1.00
$0.50
$0.00
AFC
0
Quantity of Output
10
12
Relationship Between Marginal

Cost and Average Total Cost
$3.50
$3.00
Costs
$2.50
MC
$2.00
ATC
$1.50
$1.00
$0.50
$0.00
Quantity of Output
10
12
Three Important Properties of

Cost Curves
Marginal
cost eventually rises with the

quantity of output.
Law of Diminishing Marginal Returns
The
average-total-cost curve is U-shaped.

The marginal-cost curve crosses the averagetotal-cost curve at the minimum of average
total cost.
Work on homework assignment!
Costs in the Long Run

For many firms, the division of total
costs between fixed and variable costs

depends on the time horizon being
considered.
In
the short run some costs are fixed.

In the long run fixed costs become variable
costs.
Average Total Cost in the Short

and Long Runs...
Average
Total
Cost
ATC in short
run with
small factory
ATC in short
run with
medium factory
ATC in short
run with
large factory
ATC in long run

0
Quantity of
Cars per Day
Economies and Diseconomies

of Scale
Average
Total
Cost
ATC in long run
Economies
of scale
Constant Returns
to scale
0
Diseconomies
of scale
Quantity of
Cars per Day

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Cost of Produc

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The Costs of

The Firms Objective

Total Cost includes all of the

Economic Profit versus

What happens to profit though

Diminishing Marginal Product

marginal product is the

Your Journal Question

You have just been given 10

5 Number of Workers Hired

Fixed and Variable Costs

costs are those costs that do not

Family of Total Costs

Fixed Costs (TFC)

Family of Total Costs

costs can be determined by

Family of Average Costs

Fixed Costs (AFC)

ATC = AFC + AVC

Family of Average Costs

cost (MC) measures the

much does it cost to produce an

Average-Cost and Marginal-Cost

Relationship Between Marginal

Three Important Properties of

cost eventually rises with the

average-total-cost curve is U-shaped.

Costs in the Long Run

costs between fixed and variable costs

the short run some costs are fixed.

Average Total Cost in the Short

ATC in long run

Economies and Diseconomies

ATC in long run

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