COSTS OF PRODUCTION General principle: If you know the technology of production (the production function or total product curve), and if you know the prices of the inputs to production, then you can find the firm’s costs at any level of output. Short-run costs

Put another way: Costs are determined by the technology of production and input prices. Let’s start with the total product curve for apples from the last section, and show how to get to costs of production. Short-run costs

Short-run costs

Suppose labor costs $56 per day. PL = $56/day If labor is the only variable input, we can find the total variable costs at each output level. Short-run costs

Click here for hidden slide Output Labor Wage VC (bu.) (worker-days) ($/Wkr-day) $ 56 4000 100 56 5600 16000 200 56 11200 27000 300 56 16800 32000 400 56 22400 34000 531 56 29736 35000 656 56 36736 36000 799 56 44744 37000 960 38000 1165 56 65240 39000 1411 56 79016 Click here for hidden slide Short-run costs

THE TOTAL VARIABLE COST CURVE shows the total variable cost at each level of output. In the total variable cost curve the independent variable is OUTPUT, and the dependent variable is TOTAL VARIABLE COSTS. Short-run costs

TVC Q Short-run costs

Total Cost = Fixed Cost + Total Variable Cost TC = FC + TVC If there are fixed costs (costs associated with inputs that can’t be changed), then we can add these to the total variable costs to get total costs. Total Cost = Fixed Cost + Total Variable Cost TC = FC + TVC Short-run costs

Click here for hidden slide. APPLE PRODUCTION IN A MICHIGAN ORCHARD Output VC FC TC (bu.) ($) ($) ($) 140000 140000 4000 5600 140000 145600 16000 11200 140000 151200 27000 16800 140000 156800 32000 22400 140000 162400 34000 29736 140000 169736 35000 36736 140000 176736 36000 44744 140000 184744 37000 38000 65240 140000 205240 39000 79016 140000 219016 45000 308000 140000 448000 Click here for hidden slide. Short-run costs

$ TC TVC Q Short-run costs

AVERAGE COST Average cost: Cost per unit of output. Total cost divided by output. TC/Q. Average cost curve: The curve that shows average cost as a function of output. Output is the independent variable and average cost is the dependent variable. Short-run costs

Click here for hidden slide. APPLE PRODUCTION IN A MICHIGAN ORCHARD Output TC AVC AFC AC (bu.) $ $/bu. $/bu. $/bu. 140000 N/A N/A N/A 4000 145600 1.40 35.00 36.40 16000 151200 0.70 8.75 9.45 27000 156800 0.62 5.19 5.81 32000 162400 0.70 4.38 5.08 34000 169736 0.87 4.12 4.99 35000 176736 1.05 4.00 5.05 36000 184744 1.24 3.89 5.13 37000 38000 205240 1.72 3.68 5.40 39000 219016 2.03 3.59 5.62 45000 448000 6.84 3.11 9.96 Click here for hidden slide. Short-run costs

MARGINAL COST Marginal cost: The change in total cost per unit change in output. The increase in cost due to producing one more unit of output. The slope of the total cost curve. TC / Q. Marginal cost curve: The curve that shows marginal cost as a function of output. The independent variable is output. The dependent variable is marginal cost. Short-run costs

Click here for hidden slide. APPLE PRODUCTION IN A MICHIGAN ORCHARD Output TC AVC AFC AC MC (bu.) $ $/bu. $/bu. $/bu. $/bu. 140000 N/A N/A N/A N/A 4000 145600 1.40 35.00 36.40 1.40 16000 151200 0.70 8.75 9.45 0.47 27000 156800 0.62 5.19 5.81 0.51 32000 162400 0.70 4.38 5.08 1.12 34000 169736 0.87 4.12 4.99 3.67 35000 176736 1.05 4.00 5.05 7.00 36000 184744 1.24 3.89 5.13 8.01 37000 38000 205240 1.72 3.68 5.40 11.48 39000 219016 2.03 3.59 5.62 13.78 45000 448000 6.84 3.11 9.96 38.16 Short-run costs Click here for hidden slide.

$/Q MC AC AVC Q Short-run costs

Of course, the marginal and average cost curves must conform to the usual rules about marginal and average curves. 1) When the average is rising, the marginal quantity must be greater than the average quantity. 2) When the average is falling, the marginal quantity must be less than the average quantity. 3) When the average is neither rising nor falling (at a maximum or minimum), average and marginal are equal. Short-run costs

Notice that the general shape of the AC and MC curves can be deduced by looking as the TC curve. (Review, if necessary, the techniques for finding AP and MP curves by inspecting TP curves covered in the last section.) Short-run costs

Label all of the axes and curves in the two diagrams. Short-run costs

COST CURVE SUMMARY: Costs depend output, technology, and input prices. There are two ways to depict a firm’s costs: 1) Total cost curves 2) Average and marginal cost curves Short-run costs