1. 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.
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2. Put another way:
Costs are determined by the technology of production and input prices.
Let’s start with the total product curve for tax preparation services from the last section, and show how to get to costs of production.
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3. Short-run costs

4. Suppose labor costs $48 per day. PL = $48/day
If labor is the only variable input, we can find the total variable costs at each output level.
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5. TOTAL P L = LABOR PRODUCT TVC 1 3 48 2 15 96 3 36 144 4 48 192 5 56 61 3 48 2 15 96 3 36
144 4 48
192 5 56 6 62 7 66 8 68
384
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6. 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.
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7. When output is 56, total variable costs are $240.
PLOT THE REST OF THE POINTS TO
SHOW TVC. $
700
When output is 56, total variable costs are $240.
600
500
400
300
200
100 Q 20 40 60 80
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8. Total Cost = Fixed Cost + Total Variable Cost TC = FC + TVC
If there are fixed costs (costs associated with inputs that can’t be changed), then we can add these to the total variable costs to get total costs.
Total Cost = Fixed Cost + Total Variable Cost
TC = FC + TVC
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9. The total cost curve shows the total cost of producing each output.$
700
600 TC
500
TVC
400
300
200
100 Q 20 40 60 80
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10. Here’s another total cost curve that we’ll use to introduce the concepts of average cost and marginal cost.
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11. Short-run costs

12. TC($) TC
700
600
500
400
300
200
100 2 4 6 8 10 12 14
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13. AVERAGE COST
Average cost: Cost per unit of output. Total cost divided by output. TC/Q.
Average cost curve: The curve that shows average cost as a function of output. Output is the independent variable and average cost is the dependent variable.
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14. Q TC AC
50.0
AC = TC/Q
= 97/5 1
63.0
63.0 2
71.0
35.5 3
76.0
25.3 4
82.4
20.6 5
97.0
19.4 6
130.0 7
174.0 8
233.0 9
314.0
34.9 10
460.0
46.0 11
656.0
59.6
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15. PLOT THE REST OF THE AC CURVE.
AC($/Q)
120
100 80 AC 60 40 20 Q 2 4 6 8 10 12 14
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16. AVERAGE VARIABLE COSTS CAN BE
SHOWN AT THE SAME TIME.
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17. $/Q
120
100 80 AC 60
AVC 40 20 Q 2 4 6 8 10 12 14
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18. 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.
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19. Q TC AC MC
50.0 1
63.0
63.0 13 2
71.0
35.5 8
The marginal cost
of the 4th unit of
output is 6.4
=( )/(4-3) 3
76.0
25.3 5 4
82.4
20.6
6.4 5
97.0
19.4
14.6 6
130.0
21.7 33 7
174.0
24.9 8
233.0
29.1 9
314.0
34.9 10
460.0
46.0
146 11
656.0
59.6
196
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20. AC, MC MC
120
100 AC 80 AC 60 40 Q 20 2 4 6 8 10 12 14
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21. 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.
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22. 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.)
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23. WHAT WOULD THE AVERAGE VARIABLE COST CURVE LOOK LIKE
IF WE WERE TO PUT IT ON THE SAME DIAGRAM?
$/Q MC
120
100 80 AC 60 40 20 Q 2 4 6 8 10 12 14
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24. of showing information about the firm’s costs.$
700 TC
600
500
400
300
200
100 Q
Two alternative ways
of showing information
about the firm’s costs. 2 4 6 8 10 12 14
$/Q MC
120
100 80 AC 60 40 20 Q 2 4 6 8 10 12 14
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25. COST CURVE SUMMARY: Costs depend output, technology, and input prices.
There are two ways to depict a firm’s costs:
1) Total cost curves
2) Average and marginal cost curves
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26. CHANGES IN COSTS What are the effects on costs of changes in
a) input prices?
b) the technology of production?
c) taxes on output?
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27. What are the effects on a firm’s costs of an increase in the price of an input?
The increase in the price of a variable input will raise the total variable costs of production at each output level.
This has the effect of raising both marginal and average costs.
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28. AC’ and MC’ show the effect of higher input prices.$
TC’ is the total cost curve when the price of a variable input is increased.
TC’
350
300 TC
250
200
150
100 50 Q 2 4 6 8 10 12 14
Increasing the price of an
input raises both average
and marginal costs.
$/Q 60
MC’ 50 MC 40 30
AC’
AC’ and MC’ show the effect of higher input prices. 20 AC 10 Q 2 4 6 8 10 12 14
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29. Marginal and average costs of production will be lower as a result.
An improvement in technology lowers the cost of producing each level of output.
Marginal and average costs of production will be lower as a result.
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30. IMPROVEMENTS IN TECHNOLOGY REDUCE COSTS OF PRODUCTION. TC’$ TC
350
300
IMPROVEMENTS IN TECHNOLOGY REDUCE COSTS OF PRODUCTION.
TC’
250
200
150
100 50 Q
Costs fall because the same output can be produced using fewer inputs. 2 4 6 8 10 12 14
$/Q 60 MC 50 40
MC’ AC 30
AC’ 20 10 Q 2 4 6 8 10 12 14
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31. Imposing a tax per unit of output will raise total cost by tQ, where t is the tax per unit and Q is the number of units of output sold.
The tax will raise both average and marginal costs by exactly the amount of the tax per unit of output.
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32. raise total cost by $3Q, or $3 times the quantity produced.
TC+3Q
350
300 TC
A per unit tax of $3 will
raise total cost by $3Q, or
$3 times the quantity
produced.
250
200
150
100 50 Q 2 4 6 8 10 12 14
$/Q 60
MC+3
A per unit tax of $3 will
raise average and marginal
cost by exactly $3. 50 MC 40
AC+3 30 AC 20 10 Q
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33. What is a SUBSIDY, and how does a per unit subsidy affect
a firm’s costs?
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34. CHECK UP: WHAT DO THE AC AND MC CURVES LOOK LIKE FOR THE FOLLOWING TOTAL COST CURVES?$ TC Q
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35. $ TC Q
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36. $ TC Q
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37. SUMMARY
Increases in the prices of inputs will raise the total, average, and marginal costs of production.
Improvements in technology lower total, average, and marginal costs of production.
A per unit tax of t will raise total costs by tQ, and will raise marginal and average costs by exactly t.
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