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 apples 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 $56 per day. PL = $56/day
If labor is the only variable input, we can find the total variable costs at each output level.
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5. Click here for hidden slide
Output
Labor
Wage VC
(bu.)
(worker-days)
($/Wkr-day) $ 56
4000
100 56
5600
16000
200 56
11200
27000
300 56
16800
32000
400 56
22400
34000
531 56
29736
35000
656 56
36736
36000
799 56
44744
37000
960
38000
1165 56
65240
39000
1411 56
79016
Click here for hidden slide
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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. TVC Q
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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. Click here for hidden slide.
APPLE PRODUCTION IN A MICHIGAN ORCHARD
Output VC FC TC
(bu.)
($)
($)
($)
140000
140000
4000
5600
140000
145600
16000
11200
140000
151200
27000
16800
140000
156800
32000
22400
140000
162400
34000
29736
140000
169736
35000
36736
140000
176736
36000
44744
140000
184744
37000
38000
65240
140000
205240
39000
79016
140000
219016
45000
308000
140000
448000
Click here for hidden slide.
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10. $ TC
TVC Q
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11. 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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12. Click here for hidden slide.
APPLE PRODUCTION IN A MICHIGAN ORCHARD
Output TC
AVC
AFC AC
(bu.) $
$/bu.
$/bu.
$/bu.
140000
N/A
N/A
N/A
4000
145600
1.40
35.00
36.40
16000
151200
0.70
8.75
9.45
27000
156800
0.62
5.19
5.81
32000
162400
0.70
4.38
5.08
34000
169736
0.87
4.12
4.99
35000
176736
1.05
4.00
5.05
36000
184744
1.24
3.89
5.13
37000
38000
205240
1.72
3.68
5.40
39000
219016
2.03
3.59
5.62
45000
448000
6.84
3.11
9.96
Click here for hidden slide.
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13. 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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14. Click here for hidden slide.
APPLE PRODUCTION IN A MICHIGAN ORCHARD
Output TC
AVC
AFC AC MC
(bu.) $
$/bu.
$/bu.
$/bu.
$/bu.
140000
N/A
N/A
N/A
N/A
4000
145600
1.40
35.00
36.40
1.40
16000
151200
0.70
8.75
9.45
0.47
27000
156800
0.62
5.19
5.81
0.51
32000
162400
0.70
4.38
5.08
1.12
34000
169736
0.87
4.12
4.99
3.67
35000
176736
1.05
4.00
5.05
7.00
36000
184744
1.24
3.89
5.13
8.01
37000
38000
205240
1.72
3.68
5.40
11.48
39000
219016
2.03
3.59
5.62
13.78
45000
448000
6.84
3.11
9.96
38.16
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Click here for hidden slide.

15. $/Q MC AC
AVC Q
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16. 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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17. 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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18. Label all of the axes and curves in the two diagrams.
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19. 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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