The Costs of Production 22 C H A P T E R The Costs of Production

Economic Costs or Opportunity Costs Forgoing the opportunity to produce alternative goods and services Explicit Costs Implicit Costs

ECONOMIC COSTS Normal Profits Economic or Pure Profits Treated as a cost Required to attract & retain resources Economic or Pure Profits Economic profit Total revenue Opportunity cost of all inputs

ECONOMIC COSTS Profits to an Economist Profits to an Accountant L R E V N U Economic Profit Accounting Profit Implicit costs (including a normal profit) Economic (opportunity) Costs Explicit Costs Accounting costs (explicit costs only)

Accounting: Economics: SHORT RUN AND LONG RUN Accounting: Short and long run is based upon annual chronology Economics: Short run has fixed plant capacity size Long run has variable plant capacity size

Total Product (TP) Marginal Product (MP) Average Product (AP) SHORT-RUN PRODUCTION RELATIONSHIPS Total Product (TP) Marginal Product (MP) Marginal Product = Change in Total Product Change in Labor Input Average Product (AP) Average Product = Total Product Units of Labor

Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Increasing Marginal Returns Quantity of Labor Average Product, AP, and marginal product, MP Average Product Marginal Product Quantity of Labor

Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Diminishing Marginal Returns Quantity of Labor Average Product, AP, and marginal product, MP Average Product Marginal Product Quantity of Labor

Law of Diminishing Returns SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Negative Marginal Returns Quantity of Labor Average Product, AP, and marginal product, MP Average Product Marginal Product Quantity of Labor

SHORT-RUN PRODUCTION COSTS Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Variable Costs Total Variable Costs Average Variable Costs = Total Variable Costs Quantity

SHORT-RUN PRODUCTION COSTS Total Cost Total Fixed and Variable Costs Average Total Cost = Total Costs Quantity Marginal Cost Total Variable Costs Marginal Cost = Change in Total Costs Change in Quantity

SHORT-RUN PRODUCTION COSTS Summary of Definitions Total Fixed Costs = TFC Total Variable Costs = TVC Total Costs = TC Average Fixed Costs = AFC Average Variable Costs = AVC Average Total Costs = ATC Marginal Cost = MC

SHORT-RUN COSTS GRAPHICALLY TC Combining TVC With TFC to get Total Cost TVC Fixed Cost Costs (dollars) Total Cost Variable Cost TFC Quantity

SHORT-RUN COSTS GRAPHICALLY MC Plotting Average and Marginal Costs ATC AVC Costs (dollars) AFC Quantity

PRODUCTIVITY AND COST CURVES Costs (dollars) Average product and marginal product AP MP Quantity of labor Quantity of output MC AVC

LONG-RUN PRODUCTION COSTS For every plant capacity size... There is a short-run ATC curve All such plant capacities can be plotted...

LONG-RUN PRODUCTION COSTS Unit Costs Output

LONG-RUN PRODUCTION COSTS Unit Costs Output

LONG-RUN PRODUCTION COSTS The Long-run ATC just “envelopes” all of the short-run ATC curves Unit Costs Output

LONG-RUN PRODUCTION COSTS Unit Costs Long-run ATC Output

Managerial Specialization Efficient Capital Other Factors ECONOMIES AND DISECONOMIES OF SCALE Labor Specialization Managerial Specialization Efficient Capital Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...

ECONOMIES AND DISECONOMIES OF SCALE Unit Costs Long-run ATC Output

ECONOMIES AND DISECONOMIES OF SCALE Constant returns to scale Unit Costs Long-run ATC Output

ECONOMIES AND DISECONOMIES OF SCALE Constant returns to scale Diseconomies of scale Unit Costs Long-run ATC Output

Where extensive economies of scale exist ECONOMIES AND DISECONOMIES OF SCALE Where extensive economies of scale exist Unit Costs Long-run ATC Output

ECONOMIES AND DISECONOMIES OF SCALE Where economies of scale are quickly exhausted Unit Costs Long-run ATC Output

MINIMUM EFFICIENT SCALE AND INDUSTRY STRUCTURE Minimum Efficient Scale - MES Natural Monopoly Chapter Conclusions

KEY TERMS economic (opportunity) cost explicit costs implicit costs normal profit economic profit short run long run total product (TP) marginal product (MP) average product (AP) law of diminishing returns fixed costs variable costs total cost average fixed cost (AFC) average variable cost (AVC) average total cost (ATC) marginal cost (MC) economies of scale diseconomies of scale constant returns to scale minimum efficient scale natural monopoly Copyright McGraw-Hill/Irwin 2002 BACK END

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