1. Costs of Production
Chapter 7

2. Explicit and Implicit Costs
Economic Costs – payments a firm must make, or income it must provide, to resource suppliers to attract the resources away from alternative production opportunities
Explicit and Implicit Costs
Explicit costs – monetary payments a firm must make to an outsider to obtain a resource
Implicit costs – monetary income a firm sacrifices when it uses a resource it owns rather than supplying it in the market
Normal profits are an implicit cost.
Economic profit = TR – (Explicit + Implicit)

3. Benji quit his job at Sweet and Sassy where he earned $60,000 per year
Benji quit his job at Sweet and Sassy where he earned $60,000 per year. He sold $100,000 in US Treasury bonds that earned 5% interest annually to buy a food truck that specializes in a Vegan lunch menu. After a year in business Benji has averaged 100 customers per day (he only operates on weekdays, for 50 total weeks) who spend an average of $8 each. $5 per customer covers the costs of his materials (ingredients) and maintenance on the truck. Insurance costs $3000 annually and he pays $200 for a license to operate a food truck.
What are Benji’s total revenues?
What are Benji’s explicit costs?
What are Benji’s implicit costs?
What is Benji’s accounting profit?
What is Benji’s economic profit?

4. Short Run Production Relationships (short run = fixed plant)
Total Product (TP) – total quantity produced
Marginal Product (MP) – extra output produced when one additional unit of a resource is employed
Average Product (AP) – TP per unit of a particular resource (e.g. TP / units of labor)

5. Law of Diminishing Returns (law of diminishing marginal product)
Assumptions – fixed technology, equal quality of variable resources As successive units of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decrease.

6. Graphs – MP and AP; TP

7. Short Run Production Costs
Fixed Costs – costs which do not vary with changes in output -examples: rent/mortgage, insurance -must be paid even if output is 0 -can not be avoided in the short run -industry with very high fixed costs - airlines

8. Variable Costs – costs which change with the level of output -examples: fuel, labor, materials -Initially, variable costs increase by decreasing amounts. Eventually, variable costs rise by increasing amounts (law of diminishing returns) Total Cost – sum of fixed and variable costs TC=TVC + TFC At zero output TC = TFC

9. Graph – TFC, TVC, and TC

10. Per Unit Costs (Average Costs)
Average Fixed Cost – AFC=TFC/Q Average Variable Cost – AVC = TVC/Q AVC declines initially, reaches a minimum, then increases again U shaped curve reflects law of diminishing returns Average Total Cost – ATC = TC/Q or ATC = AFC + AVC

11. Marginal Cost – extra cost of producing one more unit of output
MC is the mirror opposite of MP curve (MP max = MC min)
MC intersects AVC and ATC at their minimum points
There is no relationship between MC and AFC

12. Graph – AFC, AVC, ATC, MC

13. Long Run Production Costs
All costs are variable in the long run The long run ATC curve shows the least ATC at which any output can be produced after the firm has had time to make all adjustments in its plant size . (also called the planning curve) The long run ATC curve is made up of all the points of tangency from the short run ATC curves

14. Graph – Long Run ATC

15. Economies and Diseconomies of Scale
Economies of Scale – portion of the long run ATC where ATC declines as output expands (per unit costs are decreasing) - labor specialization - efficient use of capital -purchasing power Diseconomies of Scale – At some point expansion causes ATC to increase -executives far removed, non responsive management -workers care little about the firm

16. Graph – Minimum Efficient Scale
In a given industry, how large does a firm need to be in order to reach minimum ATC?