1. Chapter 8
The Costs of
Production

2. Chapter Objectives Explicit and implicit costs
Law of diminishing returns
Fixed and variable costs
Total, average, and marginal costs
The firm’s size in the long run
8-2

3. Economic Costs Equal to opportunity costs Explicit + implicit costs
Explicit costs
Monetary payments
Implicit costs
Value of next best use
Self-owned resources
Self-employed resources
8-3

4. Profit Accounting profit Normal profit Economic or pure profit
Total revenue less explicit cost
Normal profit
Equal to implicit cost
Economic or pure profit
Total revenue less economic cost
8-4

5. Profits Compared Economic Accounting Accounting Profit Total Revenue
Implicit Costs
(Including a
Normal Profit)
Total Revenue
(Opportunity)
Economic
Costs
Explicit
Costs
Accounting
Costs (Explicit
Costs Only)
8-5

6. Short and Long Run The short run The long run Fixed plant capacity
Variable intensity of plant use
Variable output
The long run
Variable plant capacity
Firms enter and exit
8-6

7. Production Relationships
Total product (TP)
Marginal product (MP)
Average product (AP)
Marginal Product
Change in Total Product
Change in Labor Input =
Average Product
Total Product
Units of Labor =
8-7

8. Law of Diminishing Returns
Fixed technology
Add variable resource to fixed resource
Marginal product will decline
Beyond some point
Rationale
8-8

9. Law of Diminishing Returns
(1)
Units of the
Variable Resource
(Labor)
(2)
Total Product
(TP)
(3)
Marginal Product
(MP),
Change in (2)/
Change in (1)
Average
Product
(AP),
(2)/(1) 1 2 3 4 5 6 7 8 10 25 45 60 70 75 -
10.00
12.50
15.00
14.00
10.71
8.75 ] 10 15 20 5 -5
Increasing
Marginal
Returns
Diminishing
Marginal
Returns
Negative
Marginal
Returns
8-9

10. Law of Diminishing Returns10 20 30
Total Product, TP 1 2 3 4 5 6 7 8 9 TP 20 10
Marginal Product, MP 1 2 3 4 5 6 7 8 9
Increasing
Marginal
Returns
Diminishing
Marginal
Returns
Negative
Marginal
Returns AP MP
8-10

11. Short-Run Production Costs
Fixed Costs
Do not vary with output
Variable Costs
Materials, most labor
Total Cost
TC = TFC + TVC
8-11

12. Per-Unit Production Costs
Average fixed cost
AFC = TFC/Q
Average variable cost
AVC = TVC/Q
Average total cost
ATC = TC/Q = TFC/Q + TVC/Q
ATC = AFC+AVC
Marginal cost
MC = change in TC/change in Q
8-12

13. Short-Run Production Costs1 2 3 4 5 6 7 8 9 10 Q
100
200
300
400
500
600
700
800
900
1000
$1100 TC
TVC
Fixed
Cost
Total
Cost
Variable
Cost
TFC
8-13

14. Short-Run Production Costs1 2 3 4 5 6 7 8 9 10 Q 50
100
150
$200 MC
ATC
AVC
AFC
AVC
AFC
8-14

15. Production Relationships
Marginal cost and diminishing returns
Marginal cost and marginal product
Marginal cost and average variable cost
Marginal cost and average total cost
Production curves and cost curves
Shifts in cost curves
8-15

16. Graphical Relationships
Average Product and
Marginal Product
Cost (Dollars)
Production Curves AP MP
Quantity of Labor MC
AVC
Cost Curves
Quantity of Output
8-16

17. Long-Run Production Costs
Choose your plant size
Minimize ATC
Different ATC curves
Short run
Long run ATC
Envelope of short run ATC
8-17

18. Long-Run ATC Curve Any number of short-run optimum
Average Total Costs
Output
Any number of short-run optimum
size cost curves can be constructed
8-18

19. Long-Run ATC Curve The long-run ATC curve just
Average Total Costs
Output
The long-run ATC curve just
“envelopes” the short run ATCs
8-19

20. Long Run Production Cost
Economies of Scale
Labor specialization
Managerial specialization
Efficient capital
Diseconomies of Scale
Constant Returns to Scale
8-20

21. Long-Run ATC Shapes Long-run ATC curve where economies of scale exist
Constant Returns
To Scale
Diseconomies
Of Scale
Average Total Costs
Long-Run
ATC q1 q2
Output
Long-run ATC curve where economies
of scale exist
8-21

22. Long-Run ATC Shapes Long-run ATC curve where costs are
Economies
Of Scale
Diseconomies
Of Scale
Average Total Costs
Long-Run
ATC
Output
Long-run ATC curve where costs are
lowest only when large numbers are
participating
8-22

23. Long-Run ATC Shapes Long-run ATC curve where economies
Of Scale
Diseconomies
Of Scale
Long-Run
ATC
Average Total Costs
Output
Long-run ATC curve where economies
of scale exist, are exhausted quickly,
and turn back up substantially
8-23

24. Industry Structure Minimum efficient scale (MES) Natural monopoly
Applications and illustrations
Price of corn
Successful start-up firms
The Verson stamping machine
The daily newspaper
Aircraft and concrete plants
8-24

25. Sunk Costs Irrelevant in decision making Cannot be recovered
Do not affect marginal benefit and marginal cost
Firm example:
R&D costs
8-25

26. 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 (MES)
natural monopoly
8-26

27. Next Chapter Preview…
Pure
Competition
8-27