1. 10 Businesses and the Costs of Production McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Includes normal profit
Economic Costs
The payment that must be made to obtain and retain the services of a resource
Explicit Costs
Monetary payments
Implicit Costs
Value of next best use
Self-owned resources
Includes normal profit
10-2
LO1

3. Accounting Profit and Normal Profit
= Revenue – Explicit Costs
Economic profit
= Accounting Profit – Implicit Costs
Economic profit (to summarize)
=Total Revenue – Economic Costs
=Total Revenue – Explicit Costs – Implicit Costs
10-3
LO1

4. Economic Profit Economic profit Accounting profit
Implicit costs (including a normal profit)
Total Revenue
Accounting costs (explicit costs only)
(Opportunity)
Economic
Costs
Explicit
costs
10-4
LO1

5. All inputs are variable Variable plant Firms enter and exit
Short Run and Long Run
Short Run
Some variable inputs
Fixed plant
Long Run
All inputs are variable
Variable plant
Firms enter and exit
10-5
LO1

6. Short-Run Production Relationships
Total Product (TP)
Marginal Product (MP)
Average Product (AP)
Marginal Product
Change in Total Product
Change in Labor Input =
Average Product
Total Product
Units of Labor =
10-6
LO2

7. The Law of Diminishing Returns30 TP
Total Product, TP 20 10 1 2 3 4 5 6 7 8 9
Increasing
Marginal
Returns
Diminishing
Marginal
Returns
Negative
Marginal
Returns 20
Marginal Product, MP 10 AP 1 2 3 4 5 6 7 8 9 MP
10-7
LO2

8. Short-Run Production Costs
Fixed Costs (TFC)
Costs do not vary with output
Variable Costs (TVC)
Costs vary with output
Total Costs (TC)
Sum of TFC and TVC
TC = TFC + TVC
10-8
LO3

9. Short-Run Production Costs1 2 3 4 5 6 7 8 9 10 Q
100
200
300
400
500
600
700
800
900
1000
$1100 TC
TVC
Fixed
Cost
Total
Cost
Variable
Cost
TFC
10-9
LO3

10. Per-Unit, or Average, Costs
Average Fixed Costs AFC = TFC/Q
Average Variable Costs AVC = TVC/Q
Average Total Costs ATC = TC/Q
Marginal Costs MC = ΔTC/ΔQ
10-10
LO3

11. Per-Unit, or Average, Costs1 2 3 4 5 6 7 8 9 10 Q 50
100
150
$200
ATC
AVC
AFC
AVC
AFC
10-11
LO3

12. Marginal Cost MC ATC Costs AVC AFC AVC AFC Q 1 2 3 4 5 6 7 8 9 10 50Q 50
100
150
$200 MC
ATC
AVC
AFC
AVC
AFC
10-12
LO3

13. MC and Marginal Product
Average Product and
Marginal Product
Cost (Dollars)
Production Curves AP MP
Quantity of Labor MC
AVC
Cost Curves
Quantity of Output
10-13
LO3

14. Long-Run Production Costs
The firm can change all input amounts, including plant size.
All costs are variable in the long run.
Long run ATC
Different short run ATCs
10-14
LO4

15. The Long-Run Cost Curve
ATC-1
ATC-5
ATC-2
ATC-3
ATC-4
Long-Run
ATC
Average Total Costs
Output
10-15
LO4

16. Economies and Diseconomies of Scale
Labor specialization
Managerial specialization
Efficient capital
Other factors
Constant returns to scale
10-16
LO4

17. Economies and Diseconomies of Scale
Control and coordination problems
Communication problems
Worker alienation
Shirking
10-17
LO4

18. MES and Industry Structure
Minimum Efficient Scale (MES):
Lowest level of output where long- run average costs are minimized
Can determine the structure of the industry
10-18
LO4

19. MES and Industry Structure
Economies
Of Scale
Constant Returns
To Scale
Diseconomies
Of Scale
Average Total Costs
Long-Run
ATC q1 q2
Output
10-19
LO4

20. Don’t Cry Over Sunk Costs
Costs have already been incurred and thus are irrecoverable
Rule: Do not engage in any activity where MB<MC
Rule: Ignore sunk costs
They are irrecoverable
10-20