© 2007 Thomson South-Western WHAT ARE COSTS? The economic goal of business is to maximize profits.

© 2007 Thomson South-Western Total Revenue, Total Cost, and Profit Total Revenue The amount a firm receives for the sale of its output. Total Cost The market value of the inputs a firm uses in production.

© 2007 Thomson South-Western Total Revenue, Total Cost, and Profit Profit is the firm’s total revenue minus its total cost. Profit = Total revenue - Total cost

© 2007 Thomson South-Western Costs as Opportunity Costs A firm’s cost of production includes all the opportunity costs of making its output of goods and services. Explicit and Implicit Costs A firm’s cost of production include explicit costs and implicit costs. Explicit costs are input costs that require a direct outlay of money by the firm. Implicit costs are input costs that do not require an outlay of money by the firm.

© 2007 Thomson South-Western Economic Profit When total revenue exceeds both explicit and implicit costs, the firm earns economic profit.

© 2007 Thomson South-Western Figure 1 Revenue Total opportunity costs How an Economist Views a Firm Economic profit Implicit costs Explicit costs

COST CURVES COSTS ARE EXPENSES BUSINESSES INCURE WHILE OPERATING THEIR BUSINESSES

FIXED COST THESE ARE COSTS THAT DON’T CHANGE WITH OUTPUT. FOR EXAMPLE RENT ON A BUILDING. EVERY MONTH YOU WILL PAY RENT ON YOUR BUILDING NO MATTER HOW MUCH YOU PRODUCE IN YOUR FACTORY

FIXED COST DON’T CHANGE IN THE SHORT RUN FC Q COSTS 500

FC IN SHORTRUN WOULD BE LIKE RENT OVER THE LONGRUN YOU MAY PAYOFF THE LOAN AND THEN YOU WOULD NOT HAVE RENT AS A FIXED COST

ANOTHER EXAMPLE EMPLOYEES-IF THEY ARE ON SALARY YOU KNOW EVERY MONTH THEIR SALARIES ARE A FIXED COST IN THE SHORT RUN. IN THE LONG RUN YOU MAY HIRE MORE PEOPLE OR FIRE SOME

COPY Q COSTS

VARIABLE COST THESE ARE COSTS THAT VARY WITH OUTPUT FOR EXAMPLE IF YOU MAKE MORE COOKIES IT COST YOU MORE IN DOUGH.

VARIABLE COST GO UP AS PRODUCTION GOES UP Q COSTS

TOTAL COST TC=TVC+TFC

© 2007 Thomson South-Western Figure 2 Hungry Helen’s Total-Cost Curve Total Cost Quantity of Output (cookies per hour)

© 2007 Thomson South-Western THE VARIOUS MEASURES OF COST Costs of production may be divided into fixed costs and variable costs. –Fixed costs are those costs that do not vary with the quantity of output produced. –Variable costs are those costs that do vary with the quantity of output produced.

© 2007 Thomson South-Western Fixed and Variable Costs Total Costs Total Fixed Costs (TFC) Total Variable Costs (TVC) Total Costs (TC) TC = TFC + TVC

© 2007 Thomson South-Western Table 2 The Various Measures of Cost: Thirsty Thelma’s Lemonade Stand

A CHART Q FC + VC = TC

TC=FC+VC OR YELLOW + BLUE MAKES GREEN Q COSTS VC FC TC

QUESTIONS TO SEE IF YOU WERE PAYING ATTENTION GRAPH FC!!!!! GIVE ME AN EXAMPLE LABEL AXIS ANSWER IS ON THE NEXT SLIDE

WHY IS IT FLAT? FC QUANTITY OF PRODUCTION COSTS 500 COST DOES NOT CHANGE WITH PRODUCTION OR OUTPUT RENT IS AN EXAMPLE

GRAPH VARIABLE COST ANSWER ON NEXT SLIDE GIVE AN EXAMPLE

WHY DOES VARIABLE COST GO UP? Q COSTS BECAUSE AS I MAKE MORE OF THE PRODUCT MY VARIABLE COST WILL GO UP. MY VC VARIES WITH THE AMOUNT OF PRODUCTION EXAMPLE WOULD BE SUGAR IF MAKING LEMONADE

GRAPH TC ANSWER ON NEXT SLIDE

WHAT IS THE EQUATION FOR TC? Q COSTS TC TC=FC+VC

WHAT IS THE GAP? Q COSTS VC FC TC = THE SAME DISTANCE

COOKIES(SOLVE FOR A-I) Q FC VC TC A2 C B D2 E2 G H 5.80 F I

COOKIES Q FC VC TC

© 2007 Thomson South-Western Average and Marginal Costs Marginal Cost Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production. Marginal cost helps answer the following question: How much does it cost to produce an additional unit of output?

© 2007 Thomson South-Western Average and Marginal Cost

© 2007 Thomson South-Western Thirsty Thelma’s Lemonade Stand Note how Marginal Cost changes with each change in Quantity.

© 2007 Thomson South-Western Cost Curves and Their Shapes Marginal cost rises with the amount of output produced. This reflects the property of diminishing marginal product.

LAST BUT NOT LEAST MC MC WILL BE A BIG DEAL THE REST OF THE YEAR!!!!!!! LEARN IT NOW!!!!!!

MC IS MC= MARGINAL COST IT IS THE COST TO PRODUCE THE NEXT ONE!!!!!!!!!!!!

YOU SHOULD KNOW THE EQUATION MC = TC Q

COOKIES Q FC VC TC MC A B C D E F G H

COOKIES Q FC VC TC MC

COOKIES Q FC VC TC MC

COOKIES Q FC VC TC MC

COOKIES Q FC VC TC MC

COOKIES Q FC VC TC MC

COOKIES Q FC VC TC MC

COOKIES Q FC VC TC MC

COOKIES Q FC VC TC MC

© 2007 Thomson South-Western Table 2 The Various Measures of Cost: Thirsty Thelma’s Lemonade Stand