1. Production Costs, Supply and Price Determination Chapter 6

2. Identification of Costs  Explicit Costs – those costs that are incurred when money is spent to hire labor, repair machinery, buy seed, fuel, or other things for which cash expenditures are made.  Implicit Costs – costs that are incurred in using any resource for which there was no cash outlay. (one’s own labor)

3. Opportunity Cost  The value of the benefit foregone  Example: your land is capable of producing corn or wheat and for $100 you can produce $300 worth of corn or $200 worth of wheat per acre.  What is the cost of producing wheat?  Not $100  The $300 worth of corn you have to give up.

4. Profit  Accounting Profit: AP = Income – Explicit Costs Explicit Costs include hired labor, rentals and other purchased inputs, taxes, insurance, depreciation and so on.

5. Profit  Economic Profit: EP = Income – Implicit Costs – Explicit Costs Implicit Costs include the opportunity costs of things such as your own labor, owned and depreciated equipment and land.

6. Other Cost Concepts  Fixed Costs - Costs that don’t change with the level of output.  Variable Costs - Costs that change with the level of output.

7. Length of Run  Short Run – A period of time in which at least one input is fixed in the production process. This gives rise to diminishing returns. Immediate Short Run – meaning right now, a time span so short that no resource changes can be made. Immediate Short Run – meaning right now, a time span so short that no resource changes can be made.

8. Length of Run  Long Run – A period of time in which all input usage is variable in the production process. Ultimate Long Run Ultimate Long Run

9. Total Cost Curves  Total Variable Cost (TVC) is the total spending for the variable input.  Total Fixed Cost (TFC) is the total portion of costs that don’t change with the level of output. Total Cost (TC) = TVC + TFC

10. Total Revenue  Total revenue is the value of all production achieved and sold by the firm. Total Revenue = Price x Quantity of Output

11. Short-run Costs, Revenue and Profit Output $ Total Fixed Cost Total Revenue Loss Profit Total Variable Cost Max

12. Measuring Per Unit Costs and Returns  Average Fixed Cost (AFC), the amount spent on the fixed input per unit of output. AFC = Total Fixed Cost = TFC AFC = Total Fixed Cost = TFC Output Y Output Y

13. $ Quantity Average Fixed Cost AFC

14. Measuring Per Unit Costs and Returns  Average Variable Cost (AVC), the amount spent on the variable input per unit of output. AVC = Total Variable Cost = TVC Output Y

15. Measuring Per Unit Costs and Returns  Average Total Cost (ATC), the amount spent on all inputs per unit of output. ATC = Total Cost = TC or TVC +TFC Output YY Output YY  ATC is also equal to AFC + AVC

16. ATC $ Quantity Average Total and Variable Cost AVC

17. Measuring Per Unit Costs and Returns  Marginal Cost (MC), the change in the total cost from adding an additional unit of output. MC = Marginal Cost = Δ TC ΔY ΔY

18. Marginal Cost $ Quantity MC

19. ATC AVC and MC ATC $ Quantity AVC MC

20. $ MR = D = P Quantity P*P*P*P* ATC AVC MC Shutdown Point

21. Cost Curves and the Output Decision Rule – The Search for an Optimum  How much output does one produce in order to maximize profits?  The output decision rule tells us where.  Output Decision Rule is to produce where Marginal Cost is Equal to Marginal Revenue. (MR=MC)

22. $ MR = D = P Quantity P*P*P*P* ATC AVC MC Output Decision Rule Profit Maximization MR = MC Q*Q*Q*Q*

23. Profit Per Unit  Price - ATC = Profit per unit of output  Note: Price > ATC indicates a profit  Total Profit = (Price – ATC) x Q

24. $ MC MR = D = P Quantity ATC Q*Q*Q*Q* P*P*P*P*

25. Economic Profit $ MC MR = D = P = P Quantity ATC Q*Q*Q*Q* P*P*P*P*

26. Average Total Cost and Profit  Price - ATC = Profit per unit of output  Note: Price < ATC indicates a loss

27. $ Quantity

28. $ MR = D = P Quantity P*P*P*P* How the Firm Sees Its Demand Curve

29. $ MC MR = D = P Quantity P*P*P*P*

30. $ MC Quantity ATC P*P*P*P*

31. $ MC Quantity ATC Q*Q*Q*Q* P*P*P*P*

32. $ MC Quantity ATC Q*Q*Q*Q* P*P*P*P* Economic Loss

33. $ MC MR = D = P Quantity P*P*P*P* Firm’s Short Run Supply Curve MC Curve Above AVC AVC