The Cost Curve Model Chapter 13 Cost Curves

Review: The Production Function TP MP AP (total output) Law of diminishing Marginal product (average output Per-worker) Shape of product curves will determine shape of costs curves (marginal output Next worker)

Opportunity Costs A firm’s cost curves must include all opportunity costs Both explicit & implicit Explicit costs- input costs that require a direct outlay of money Example: attending college => tuition, books, etc…. Implicit costs- input costs that do not require an outlay of money Example: attending college => can’t work (loss of income)

Economic Profit vs. Accounting Profit Economic profit = total revenue - total costs both explicit & implicit costs Accounting profit = total revenue - explicit costs no implicit costs! Economic profit is smaller than accounting profit Firms maximize economic profit All cost curves include both implicit & explicit costs

Economists vs. Accountants How an Economist How an Accountant Views a Firm Views a Firm Total Revenue $1,000 Economic Profit $825 1) Value of your time 2) Loss of interest income on money invested 3) Etc…. Accounting Profit $900 Total Revenue $1,000 Implicit Costs $75 Total opportunity costs Explicit Costs $100 Explicit Costs $100 Anything paid for in dollars

Costs of Production Fixed costs - do not change with quantity of output Rent on factory, machinery, insurance, etc…. (they are sunk!) Variable costs - increase with quantity of output Cost of workers, cost of other inputs, etc… Marginal cost increase in total cost from next unit of production Cost to produce one additional good or service Total Costs = Fixed Costs + Variable Costs

Marginal Costs (MC) = ∆ Total Cost . Total Cost @ 3 units:$4.50 Total Cost @ 4 units:$5.40 MC of 4th unit = $0.90 ($5.40 - $4.50 = +0.90)

Cost Curve Model Cost Curve Model uses average cost curves Variable Costs Cost Curve Model uses average cost curves AFC = FC/Qty AVC = VC/Qty ATC = TC/Qty MC = ∆ TC (for 1 more unit) Fixed Costs Total Cost

Worksheet: Cost Curve Model