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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.

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A Firms Profit

Profitis the firms total revenue minus itstotal cost.

Profit = Total revenue - Total cost

Total Cost includes all of theopportunity costs of production

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Economic Profit versus

Accounting Profit

Revenue

Total

opportunitycosts

How an EconomistViews a Firm

Explicitcosts

Economicprofit

Implicitcosts

Explicitcosts

Accountingprofit

How an AccountantViews a Firm

Revenue

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What happens to profit though

as you keep on addingworkers?

Additional inputAdditional output

=

Marginalproduct

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Diminishing Marginal Product

Diminishing marginal productis 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.

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Your Journal Question

You have just been given 10

acres of land.

The land is of varying quality.

The amount of land remainsfixed.

What will happen to your

yield as you keep on adding

workers?

Can you write down anexample of diminishing

returns from your

experience?

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Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

A Produc t ion Funct ion...

Quantity ofOutput

(cookiesper hour)

150

140

130

120

110

100

90

80

70

6050

40

30

20

10

Number of Workers Hired0 1 2 3 4 5

Production function

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Fixed and Variable Costs

Fixed costsare those costs that do notvary with the quantity of output

produced.Variable costsare those costs that do

change as the firm alters the quantity ofoutput produced.

Short Run vs. Long Run Costs

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Family of Total Costs

Total Fixed Costs (TFC)

Total Variable Costs (TVC)Total Costs (TC)

TC = TFC + TVC

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Total-Cos t Curve...

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

$16.00

0 2 4 6 8 10 12

Quantity of Output

(glasses of lemonade per hour)

TotalCost

Total-costcurve

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Relation

Between

ProductionFunction

and Total

Cost.

Dimininishing

Returns

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Average Costs

Average costscan 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.

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Family of Average Costs

Average Fixed Costs (AFC)

Average Variable Costs (AVC)

Average Total Costs (ATC)

ATC = AFC + AVC

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$3.00

Family of Average Costs

Quantity AFC AVC ATC0 1 $0.30 $3.302 1.50 0.40 1.90

3 1.00 0.50 1.504 0.75 0.60 1.355 0.60 0.70 1.30

6 0.50 0.80 1.307 0.43 0.90 1.338 0.38 1.00 1.389 0.33 1.10 1.43

10 0.30 1.20 1.50

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ATC

AVC

MC

Average-Cos t and Marg inal-Cos t

Curves...

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

0 2 4 6 8 10 12

Quantity of Output

(glasses of lemonade per hour)

Costs

AFC

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MC

ATC

Relationship Between Marginal

Cost and Average Total Cost

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

0 2 4 6 8 10 12

Quantity of Output

(glasses of lemonade per hour)

Costs

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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 average-

total-cost curve at the minimum of average

total cost.

Work on homework assignment!

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Costs in the Long Run

For many firms, the division of total

costs between fixed and variable costs

depends on the time horizon beingconsidered.

In the short run some costs are fixed.

In the long run fixed costs become variablecosts.

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Average Total Cos t in the Sho rt

and Long Runs...

Quantity ofCars per Day

0

AverageTotalCost

ATC in shortrun with

small factory

ATC in shortrun with

medium factory

ATC in shortrun with

large factory

ATCin long run

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