1. The Costs of Production22
C H A P T E R
The Costs of Production

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

3. 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

4. ECONOMIC COSTS Profits to an Economist Profits to an AccountantL 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)

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. SHORT-RUN COSTS GRAPHICALLYTC
Combining TVC
With TFC to get
Total Cost
TVC
Fixed Cost
Costs (dollars)
Total
Cost
Variable Cost
TFC
Quantity

14. SHORT-RUN COSTS GRAPHICALLYMC
Plotting Average and
Marginal Costs
ATC
AVC
Costs (dollars)
AFC
Quantity

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

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

17. LONG-RUN PRODUCTION COSTS
Unit Costs
Output

18. LONG-RUN PRODUCTION COSTS
Unit Costs
Output

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

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

21. 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...

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

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

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

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

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

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

28. 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

29. NEXT:
Pure Competition
Chapter 23