The costs of production. Chapter 8

Chapter Objectives

Explicit and implicit costs
Law of diminishing returns
Fixed and variable costs
Total,

Economic Costs

Equal to opportunity costs
Explicit + implicit costs
Explicit costs
Monetary payments
Implicit costs
Value

Profit

Accounting profit
Total revenue less explicit cost
Normal profit
Equal to implicit cost
Economic

Profits Compared

Economic
Profit

Accounting
Costs (Explicit
Costs Only)

Accounting
Profit

Explicit
Costs

Implicit Costs
(Including a
Normal Profit)

Economic
(Opportunity)
Costs

Total Revenue

8-

Short and Long Run

The short run
Fixed plant capacity
Variable intensity of plant

Production Relationships

Total product (TP)
Marginal product (MP)
Average product (AP)

8-

Law of Diminishing Returns

Fixed technology
Add variable resource to fixed resource
Marginal product

Increasing
Marginal
Returns

Law of Diminishing Returns

0
1
2
3
4
5
6
7
8

0
10
25
45
60
70
75
75
70

10
15
20
15
10
5
0
-5

-
10.00
12.50
15.00
15.00
14.00
12.50
10.71
8.75

Diminishing
Marginal
Returns

Negative
Marginal
Returns

8-

TP

MP

AP

Increasing
Marginal
Returns

Diminishing
Marginal
Returns

Negative
Marginal
Returns

Law of Diminishing Returns

8-

Short-Run Production Costs

Fixed Costs
Do not vary with output
Variable Costs
Materials, most labor
Total

Per-Unit Production Costs

Average fixed cost
AFC = TFC/Q
Average variable cost
AVC =

Short-Run Production Costs

TFC

TC

TVC

Total
Cost

Variable
Cost

Fixed
Cost

8-

Short-Run Production Costs

AFC

MC

ATC

AVC

AVC

AFC

8-

Production Relationships

Marginal cost and diminishing returns
Marginal cost and marginal product
Marginal cost

Graphical Relationships

MP

AP

MC

AVC

Quantity of Output

Quantity of Labor

Production Curves

Cost Curves

8-

Long-Run Production Costs

Choose your plant size
Minimize ATC
Different ATC curves
Short run
Long run

Long-Run ATC Curve

Average Total Costs

ATC-1

ATC-2

ATC-3

ATC-4

ATC-5

Output

Any number of short-run optimum
size cost

Long-Run ATC Curve

Long-Run
ATC

Average Total Costs

ATC-1

ATC-2

ATC-3

ATC-4

ATC-5

Output

The long-run ATC curve just
“envelopes” the short

Long Run Production Cost

Economies of Scale
Labor specialization
Managerial specialization
Efficient capital
Diseconomies of Scale
Constant

Long-Run ATC Shapes

Output

Long-run ATC curve where economies
of scale exist

Average Total Costs

Long-Run
ATC

Economies
Of

Output

Long-run ATC curve where costs are
lowest only when large numbers are
participating

Average

Output

Long-run ATC curve where economies
of scale exist, are exhausted quickly,
and turn

Industry Structure

Minimum efficient scale (MES)
Natural monopoly
Applications and illustrations
Price of corn
Successful start-up

Sunk Costs

Irrelevant in decision making
Cannot be recovered
Do not affect marginal benefit

Key Terms

economic (opportunity) cost
explicit costs
implicit costs
normal profit
economic profit
short run
long run
total product