The Cost Function Chapter 13

The Production Function TP MP AP Shape of product curves determines the costs curves for a business

Opportunity Costs A firm’s cost of production must include all opportunity costs Both explicit & implicit Explicit costs- input costs that require a direct outlay of money Example: attending college => tuition, books, etc…. Implicit costs- input costs that do not require an outlay of money Example: attending college => can’t work (loss of income)

Economic Profit vs. Accounting Profit Economic profit = total revenue - total costs both explicit & implicit costs Accounting profit = total revenue - explicit costs no implicit costs! Economic profit is smaller than accounting profit Firms maximize economic profit All cost curves include both implicit & explicit costs

Economists vs. Accountants How an Economist How an Accountant Views a Firm Views a Firm Total Revenue $1,000 Economic Profit $825 1) Value of your time 2) Loss of interest income on money invested 3) Etc…. Accounting Profit $900 Total Revenue $1,000 Implicit Costs $75 Total opportunity costs Explicit Costs $100 Explicit Costs $100 Anything paid for in dollars

Costs of Production Fixed costs - do not change with quantity of output Rent on factory, utilities, insurance, etc…. (they are sunk!) Variable costs - change with quantity of output # workers, qty of steel, other inputs etc… Marginal cost measures the increase in total cost that arises from an extra unit of production How much does it cost to produce one additional unit of output?

Costs of Production FC + VC = TC Variable Costs Fixed Costs Total Cost Fixed Costs (FC) Variable Costs (VC) Total Costs (TC)

Marginal Costs = ∆ Total Cost Total Cost @ 3 units: $4.50 Total Cost @ 4 units: $5.40 Marginal Cost of 4th unit = $0.90

Worksheet: The Cost Function