1. Chapter 7 Production Costs
Lecture Slides
Economics for Today Irvin B. Tucker
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2. What is the purpose of this chapter?
The purpose of this chapter is to study production and its relationship to various types of costs
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3. What is a basic assumption in economics?
The motivation for business decisions is profit maximization
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4. To understand profit, what is necessary?
To distinguish between the way economists measure costs and the way accountants measure costs
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5. What are explicit costs?
Payments to nonowners of a firm for their resources
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6. What are implicit costs?
The opportunity costs of using resources owned by the firm
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7. What is an example of implicit costs?
When a firm uses its own resources, such as the owner’s labor, land, building, or savings, the firm gives up the opportunity of earning a return on its resources.
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8. What are total opportunity costs?
Explicit costs + Implicit costs
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9. What is economic profit?
Total revenue minus explicit and implicit costs, or total revenue minus total opportunity costs
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10. © 2011 South-Western, a part of Cengage Learning
What is normal profit?
The minimum profit necessary to keep a firm in operation
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11. What about opportunity cost?
A firm that earns normal profits earns total revenue equal to its total opportunity cost
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12. How is accounting profit defined?
Total revenue minus total explicit costs
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14. What conclusion can we make?
Since business decision making is based on economic profit, rather than accounting profit, the word profit in this text always means economic profit
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15. © 2011 South-Western, a part of Cengage Learning
What is a fixed input?
Any resource for which the quantity cannot change during the period of time under consideration
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16. What is a variable input?
Any resource for which the quantity can change during the period of time under consideration
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17. © 2011 South-Western, a part of Cengage Learning
What is the short run?
A period of time so short that there is at least one fixed input
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18. © 2011 South-Western, a part of Cengage Learning
What is the long run?
A period of time so long that all inputs are variable
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19. What is the production function?
The relationship between the maximum amounts of outputs a firm can produce and various quantities of inputs
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20. What do technological advances make possible?
More output is possible from a given quantity of inputs
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21. What is marginal product?
The change in total output produced by adding one unit of a variable input, with all other inputs used held constant
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22. What is the law of diminishing returns?
The principle that beyond some point the marginal product decreases as additional units of a variable resource are added to a fixed factor
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23. What does the law of diminishing returns assume?
Fixed inputs; it is therefore a short-run concept
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24. © 2011 South-Western, a part of Cengage Learning

25. Exhibit 2 (a) Total Output Curve60 50 40
Total Product
(bushels of grapes per day) 30
Total Output 20 10 1 2 3 4 5 6
Quantity of Labor
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(number of workers per day)

26. Exhibit 2(b) Marginal Product Curve12 10 8
Marginal Product 6
(bushels of grapes per day)
Marginal Product
Law of Diminishing Returns 4 2 1 2 3 4 5 6
Quantity of Labor
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(number of workers per day)

27. What is total fixed cost?
Costs that do not vary as output varies and that must be paid even if output is zero. For example, rent, interest on loans, and property taxes.
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28. What is total variable cost?
Costs that are zero when output is zero and vary as output varies. Examples are wages, electricity, fuel, and materials.
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29. © 2011 South-Western, a part of Cengage Learning
What is total cost?
The sum of total fixed cost and total variable cost at each level of output
TC = TFC + TVC
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30. What is average fixed cost?
Total fixed cost divided by the quantity of output produced
AFC = TFC / Q
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31. What is average variable cost?
Total variable cost divided by the quantity of output produced
AVC = TVC / Q
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32. What is average total cost?
Total cost divided by the quantity of output produced. Also called per-unit cost.
ATC = TC/Q OR ATC=AFC +AVC
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33. © 2011 South-Western, a part of Cengage Learning
What is marginal cost?
The change in total cost when one unit of output is produced
MC = TC/Q
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34. © 2011 South-Western, a part of Cengage Learning3
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35. Exhibit 4(a) Short-Run Cost Curves Quantity of Output (units per hour)
800 TC
700
TVC
600
500
Total Costs (dollars)
400
TFC
300
200
TFC
100 2 4 6 8 10 12
Quantity of Output (units per hour) 35
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36. Exhibit 4(b) Short-Run Cost Curves
160
140 MC
120
100
Cost per unit (dollars) 80
ATC 60
AVC
AFC 40 20
AFC 2 4 6 8 10 12
Quantity of output (units per hour) 36
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37. © 2011 South-Western, a part of Cengage Learning5
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38. What is the marginal-average rule?
When MC < AC, AC falls
When MC > AC, AC rises
If MC = AC, AC at minimum
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39. What is the relationship between slopes of the MC and MP curves?
The rising portion of the MP curve corresponds to the declining portion of the MC curve, and vice versa
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40. © 2011 South-Western, a part of Cengage Learning
What is the relationship between the minimum and maximum points of the MR and MP curves?
The maximum point of the MP curve corresponds to the minimum point of the MC curve
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41. Marginal cost’s mirror image
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42. Exhibit 6(a) Marginal Product Curve12 10 8
Marginal Product 6
(bushels of grapes per day)
Marginal Product
Law of Diminishing Returns 4 2 1 2 3 4 5 6
Quantity of Labor
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(number of workers per day)

43. Minimum Exhibit 6(b) Marginal Cost Curve MC 24 2016
Marginal Cost (dollars) 12 8
Minimum 4
Quantity of output (bushels of grapes per day)
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44. What is the long-run average cost curve?
The curve that traces the lowest cost per unit at which a firm can produce any level of output when the firm can build any desired plant size
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45. Cost per unit (dollars) Quantity of Output (units per hour)
Exhibit 7 The Relationship Between Three Factory Sizes and the Long-Run Average Cost Curves
SRATCs
SRATCm
SRATCl 50
Cost per unit (dollars) B D 40
LRAC 30 C A 20 10 2 4 6 8 10 12 14 16
Quantity of Output (units per hour) 45
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46. Short-run average total cost curves
Exhibit 8 Long-run Average Cost Curves
Short-run average total cost curves 12 10
Cost per unit (dollars) 8 6 4 2
Long-run average cost curve 2 4 6 8 10 12 14 16
Quantity of Output (units per hour)
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47. What are economies of scale?
A situation in which the long-run average cost curve declines as the firm increases output
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48. What are constant returns to scale?
A situation in which the long-run average cost curve does not change as the firm increases output
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49. What are diseconomies of scale?
A situation in which the long-run average cost curve rises as the firm increases output
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50. Exhibit 9 Long-run Average Cost Curve Cost per unit (dollars)
LRAC
Cost per unit (dollars)
Constant returns to scale
Diseconomies of scale
Economies of scale Q1 Q2
Quantity of Output 50
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51. END