COSTS OF PRODUCTION

Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments Implicit costs Value of next best use Self-owned resources (rent) Self-employed resources (labor) 8-2

Profit Accounting profit Total revenue less explicit cost Normal profit Equal to implicit cost Economic or pure profit Total revenue less economic cost 8-3

Profits Compared Economic Profit Accounting Costs (Explicit Costs Only) Accounting Profit Explicit Costs Implicit Costs (Including a Normal Profit) Economic (Opportunity) Costs Total Revenue Economic Accounting 8-4

Definition of the “Short-Run” We will look at both short-run and long-run production costs. Short-run is NOT a set specific amount of time. The short-run is a period in which at least one resource is fixed. –Plant capacity/size is NOT changeable In the long-run ALL resources are variable –NO fixed resources –Plant capacity/size is changeable Today we will examine short-run costs 5 Copyright ACDC Leadership 2015

Total Costs FC = Total Fixed Costs VC = Total Variable Costs TC = Total Costs Per Unit Costs AFC = Average Fixed Costs AVC = Average Variable Costs ATC = Average Total Costs MC = Marginal Cost Different Economic Costs 6 Copyright ACDC Leadership 2015

Fixed Costs: Costs for fixed resources that DON’T change with the amount produced Ex: Rent, Insurance, Managers Salaries, etc. Average Fixed Costs = Fixed Costs Quantity Variable Costs: Costs for variable resources that DO change as more or less is produced Ex: Raw Materials, Labor, Electricity, etc. Average Variable Costs = Variable Costs Quantity Definitions 7 Copyright ACDC Leadership 2015

Total Cost: Sum of Fixed and Variable Costs Average Total Cost = Total Costs Quantity Marginal Cost: Marginal Cost = Change in Total Costs Change in Quantity Additional costs of an additional output. Ex: If the production of two more output increases total cost from $100 to $120, the MC is _____. Definitions $10 8 Copyright ACDC Leadership 2015

Calculating Costs Output Variable Cost Fixed Cost Total Cost Marginal Cost 0$0$ $17 3$25 4$40 5$60 6$110 9 Copyright ACDC Leadership 2015 $10 $20 $27 $35 $50 $70 $120 - $10 $7 $8 $15 $20 $50 Let’s go column by column…

Total Cost Curves Quantity TC Fixed Cost VC FC FC + VC = TC $10 10 Costs Copyright ACDC Leadership 2015

Calculating Costs 11 Now Calculate: ATC AFC AVC

Calculating Costs Fill in the table 12

Calculating Costs Output Variable Cost Fixed Cost Total Cost Marginal Cost 0$0$ $20$10 2$17$10$27$7 3$25$10$35$8 4$40$10$50$15 5$60$10$70$20 6$110$10$120$50 13 Copyright ACDC Leadership 2015 Notice any relationships between average costs? -Shape of curves -AVC + AFC = ATC AVCAFCATC --- $10 $20 $8.50$5$13.50 $8.33$3.33$11.66 $10$2.50$12.50 $12$2$14 $18.33 $1.67$20

Calculating Costs 14 Copyright ACDC Leadership 2015 AVCAFCATC --- $10 $20 $8.50$5$13.50 $8.33$3.33$11.66 $10$2.50$12.50 $12$2$14 $18.33 $1.67$20

AVC ATC $20 $18 $16 $14 $12 $10 $8 $6 $4 $ MC 15 Costs AFC Copyright ACDC Leadership 2015 Average Fixed Cost ATC and AVC get closer and closer but NEVER touch Quantity

AVC ATC $20 $18 $16 $14 $12 $10 $8 $6 $4 $ MC 16 AFC Copyright ACDC Leadership 2015 Show TC, VC, and FC of the 5 th Unit Costs

Practice 17

Copyright ACDC Leadership Audit Exam

1. 2.

Why does marginal cost always go down then up? Quantity Costs MC 20 Copyright ACDC Leadership 2015

Relationship between Production and Cost MP MC As more workers are hired, their marginal product increases and then eventually decreases because of the law of diminishing marginal returns 21 The additional costs (MC) of the units they produce fall when MP goes up, but eventually increase as additional workers produce less and less output MP and MC are mirror images of each other Quantity of output Quantity of labor Output Costs Copyright ACDC Leadership 2015

Average Product and Marginal Product Cost (Dollars) Graphical Relationships MP AP MC AVC Quantity of Output Quantity of Labor Production Curves Cost Curves 8-22

MC ATC Why does ATC go down then up? When the marginal cost is below the average, it pulls the average down. When the marginal cost is above the average, it pulls the average up. Relationship between Production and Cost Example: The average income in the room is $50,000. An additional (marginal) person enters the room: Bill Gates. If the marginal is greater than the average it pulls it up. Notice that MC can increase but still pull down the average. MC intersects the ATC curve at ATC’s lowest point 23 Quantity Costs Copyright ACDC Leadership 2015

Copyright ACDC Leadership Audit Question 23

2010 Question 18 Copyright ACDC Leadership 2015

Quantity Costs AFC AVC ATC MC $12 $10 $8 $2 When in doubt, graph it out 100 Copyright ACDC Leadership 2015

1. 2.

Shifting Cost Curves 28 Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC What if Fixed Costs increase to $ Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC Which Per Unit Cost Curves Change? 32 Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC ONLY AFC and ATC Increase! 33 Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC ONLY AFC and ATC Increase! 34 Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC If fixed costs change ONLY AFC and ATC Change! MC and AVC DON’T change! 35 Copyright ACDC Leadership 2015

Quantity Costs (dollars) AFC AVC ATC MC Shift from an increase in a Fixed Cost ATC 1 AFC 1 36 Copyright ACDC Leadership 2015

Quantity Costs (dollars) MC Shift from an increase in a Fixed Cost ATC 1 AVC AFC 1 37 Copyright ACDC Leadership 2015

Shifting Costs Curves TPVCFCTCMCAVCAFCATC What if the cost for variable resources increase 38 Copyright ACDC Leadership 2015

TPVCFCTCMCAVCAFCATC Shifting Costs Curves 39 Copyright ACDC Leadership 2015

TPVCFCTCMCAVCAFCATC Shifting Costs Curves 40 Copyright ACDC Leadership 2015

TPVCFCTCMCAVCAFCATC Shifting Costs Curves Which Per Unit Cost Curves Change? 41 Copyright ACDC Leadership 2015

TPVCFCTCMCAVCAFCATC Shifting Costs Curves MC, AVC, and ATC Change! 42 Copyright ACDC Leadership 2015

TPVCFCTCMCAVCAFCATC Shifting Costs Curves MC, AVC, and ATC Change! 43 Copyright ACDC Leadership 2015

TPVCFCTCMCAVCAFCATC Shifting Costs Curves If variable costs change MC, AVC, and ATC Change! 44 Copyright ACDC Leadership 2015

Quantity Costs (dollars) AFC AVC ATC MC ATC 1 AVC 1 Shift from an increase in a Variable Costs MC 1 45 Copyright ACDC Leadership 2015

Quantity Costs (dollars) AFC ATC 1 AVC 1 Shift from an increase in a Variable Costs MC 1 46 Copyright ACDC Leadership 2015

Shifts in Cost Curves Practice: Which curves shift and how? –Decrease in union wage requirements? AVC, ATC, MC shift DOWN –Increase in rent? AFC, ATC, shift UP –Increase in cost of materials? AVC, ATC, MC shift UP –More efficient production technology is discovered? AVC, ATC, MC shift DOWN