In this chapter you will: Examine what items are included in a firm’s costs of production, analyze the link between a firm’s production process and its total costs, learn the meaning of average total cost and marginal cost and how they are related, consider the shape of a typical firm’s cost curves, examine the relationship between short-run and long-run costs.
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, The Firm’s Objective The economic goal of the firm is to maximize profits Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc A Firm’s Profit Profit is the firm’s total revenue minus its total cost Profit = Total revenue - Total cost Total Cost includes all of the opportunity costs of production Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Economic Profit versus Accounting Profit How an Economist Views a Firm How an Accountant Views a Firm Economic profit Revenue Accounting profit Implicit costs Explicit costs Revenue Total opportunity costs Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Explicit costs What happens to profit though as you keep on adding workers? Marginal = product Additional output Additional input Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 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. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 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? Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Family of Total Costs Total Fixed Costs (TFC) Total Variable Costs (TVC) Total Costs (TC) TC = TFC + TVC Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Family of Total Costs Quantity 10 Total Cost $ 3.00 3.30 3.80 4.50 5.40 6.50 7.80 9.30 11.00 12.90 15.00 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Fixed Cost Variable Cost $3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 $ 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 Totalcost 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) Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 10 12 Relation Between Production Function and Total Cost Dimininish ing Returns Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Average Costs Average costs can be determined by dividing the firm’s costs by the quantity of output produced. The average cost is the cost of each typical unit of product. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Family of Average Costs Average Fixed Costs (AFC) Average Variable Costs (AVC) Average Total Costs (ATC) ATC = AFC + AVC Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Family of Average Costs Quantity 10 AFC — $3.00 1.50 1.00 0.75 0.60 0.50 0.43 0.38 0.33 0.30 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc AVC — $0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 1.10 1.20 ATC — $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? Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Marginal Cost (Change in total cost) MC = (Change in quantity) = ∆TC ∆Q Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Average-Cost and Marginal-Cost Curves $3.50 $3.00 Costs $2.50 MC $2.00 AT C AVC $1.50 $1.00 $0.50 $0.00 AFC Quantity of Output (glasses of lemonade per hour) Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 10 12 Relationship Between Marginal Cost and Average Total Cost $3.50 $3.00 Costs $2.50 MC $2.00 AT C $1.50 $1.00 $0.50 $0.00 Quantity of Output (glasses of lemonade per hour) Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 10 12 Three Important Properties of Cost Curves Marginal cost eventually rises with the quantity of output Law of Diminishing Marginal Returns The averagetotalcost curve is Ushaped The marginalcost curve crosses the average totalcost curve at the minimum of average total cost Work on homework assignment! Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc 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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Quantity of Cars per Day Economies and Diseconomies of Scale Average Total Cost ATC in long run Economies of scale Constant Returns to scale Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Diseconomies of scale Quantity of Cars per Day ... 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 ... total cost Profit = Total revenue - Total cost Total Cost includes all of the opportunity costs of production Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Economic Profit.. .The Firm’s Objective The economic goal of the firm is to maximize profits Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc A Firm’s Profit Profit is the firm’s total revenue minus its