Prof. Ana Corrales ECO 2023 Notes Ch. 22: The Costs of Production Economic/Opportunity Cost: Value or worth of any resource used to produce a good from its best alternative use  Payments a firm must make or income a firm must provide to attract the resources it needs from alternative production opportunities  Involves Explicit and Implicit Costs

Prof. Ana Corrales ECO 2023 Notes Explicit and Implicit Costs Explicit costs are payments for the use of resources owned by others Implicit costs are the opportunity costs of using self-owned, self-employed resources at the value of their best alternative use Economic costs = Explicit + Implicit Costs

Prof. Ana Corrales ECO 2023 Notes Normal and Economic Profits Economic costs includes Normal Profit (e.g., Entrepreneurial Income) Economic Profit (or Pure Profit) = Total Revenue – Economic Costs

Prof. Ana Corrales ECO 2023 Notes Short-run v. Long-run Short-run: Period too short for suppliers or producers to alter plant capacity  Can only change intensity of “fixed plant production” Long-run: Period long enough to change any or all resources needed for production  “Variable plant” production

Prof. Ana Corrales ECO 2023 Notes Short-run Production Total Product (TP) = Total quantity produced Marginal Product (MP) = Change in TP / Change in Labor Average Product (AP) = TP / Units of Labor  Measures how productive each unit of labor is  Labor Productivity

Prof. Ana Corrales ECO 2023 Notes Law of Diminishing Returns As successive units of a variable resource are added to a fixed resource, at some point, marginal product from each additional unit of that variable resource will decline  At some point, overcrowding sets in  Assumes all units of labor are of equal quality

Prof. Ana Corrales ECO 2023 Notes Short-Run Production Costs Fixed Costs: Costs which do not change with output Variable Costs: Costs that change with the level of output Total Costs = Fixed Costs + Variable Costs at each level of output

Prof. Ana Corrales ECO 2023 Notes Average Costs Average Fixed Cost (AFC) = Total Fixed Cost (TFC) / Quantity (Q)  Declines as output increases Average Variable Cost (AVC) = Total Variable Cost (TVC) / Quantity Average Total Cost (ATC) = AFC + AVC

Prof. Ana Corrales ECO 2023 Notes Marginal Cost Cost of producing one additional unit of output MC = ΔTC / ΔQ Quantifies all the costs incurred in producing the last unit of output If that last unit of output is not produced, the firm can “save” this cost

Prof. Ana Corrales ECO 2023 Notes Figure 22.6 Note the relationship between MP and AP Note the relationship between MC and AVC

Prof. Ana Corrales ECO 2023 Notes Long-run Production Costs Unlimited number of short-run ATC curves, one for each output level The long-run ATC curve is made up of all the short0run ATC curves  Figure 9.8  U-shaped Law of Diminishing Returns does not apply in L- R No fixed resource, all production resources are variable

Prof. Ana Corrales ECO 2023 Notes Economies of Scale Economies of mass production explains downward-sloping L-R ATC curve Labor Specialization Managerial Specialization Efficient Capital Learning by doing

Prof. Ana Corrales ECO 2023 Notes Diseconomies of Scale It is difficult to control and coordinate a firm’s operations as it becomes a large scale producer Expansion creates communication and cooperation problems, bureaucracy, hierarchy, and decision-making slows down  Results: Impaired efficiency and rising ATC

Prof. Ana Corrales ECO 2023 Notes Constant Returns to Scale Range over which L-R ATC does not change Increase in inputs results in a proportionate increase in output

Prof. Ana Corrales ECO 2023 Notes Ch. 22 Study Questions