1. Costs of Production Chapter 13 (Week 10)

2. Key Assumption: Profit Maximization
Profit = Total Revenue – Total Cost

3. Total Cost: all opportunity costs
Explicit vs. Implicit
Examples of implicit costs: income that could have been earned by firm’s owner, investment return that could have been made on money put into the firm.

4. Economists vs. Accountants
How an Economist
How an Accountant
Views a Firm
Views a Firm
Revenue
Economic
profit
Accounting
profit
Revenue
Implicit
costs
Total
opportunity
costs
Explicit
costs
Explicit
costs
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5. Production Function Workers (L) Output (Q) 1 50 2 90 40 3 120 30 4 140
Marginal Product
(dQ/ dL) 1 50 2 90 40 3
120 30 4
140 20 5
150 10

6. Production Function

7. From the Production Function to the Total-Cost Curve
For total cost curve, quantity is marked along the horizontal axis and total cost is marked along the vertical.
For every quantity, calculate the total cost.

8. Total Cost = Fixed Cost + Variable Cost
Fixed Cost: cost of setting up the business (plant & equipment), fixed costs are the same regardless of the quantity produced.
Variable Cost: labor and raw materials that can be varied with the scale of operation.

9. Calculating Total CostQ FC VC TC 30 1 50 10 40 2 90 20 3
120 60 4
140 70 5
150 80

10. Total-Cost Curve

11. The following table shows a fisherman’s output
The following table shows a fisherman’s output. Calculate the marginal product for each hour worked. Does he experience diminishing returns? Suppose the opportunity cost of his time is $5/hour and his fixed cost is $10. Graph his total cost function.
Hours
Quantity of Fish 1 10 2 18 3 24 4 28 5 30

12. Five Different Cost Curves
Total Cost (TC)
Average Total Cost (ATC = TC/Q)
Average Fixed Cost (AFC = FC/Q)
Average Variable Cost (AVC = VC/Q)
Marginal Cost (MC = TC/ Q)

13. Calculating Marginal CostQ TC MC
3.00
--- 1
3.30
0.30 2
3.80
0.50 3
4.50
0.70 4
5.40
0.90 5
6.50
1.10 6
7.80
1.30 7
9.30
1.50 8
11.00
1.70 9
12.90
1.90 10
15.00
2.10

14. Thirsty Thelma’s Total-Cost Curve

15. Figure 5 Thirsty Thelma’s Average-Cost and Marginal-Cost Curves
Costs
$3.50
3.25
3.00
2.75
2.50
2.25 MC
2.00
1.75
1.50
ATC
1.25
AVC
1.00
0.75
0.50
AFC
0.25 1 2 3 4 5 6 7 8 9 10
Quantity
of Output
(glasses of lemonade per hour)
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16. Adam Smith in the Pin Factory
One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on is a peculiar business; to whiten it is another; it is even a trade by itself to put them into paper.
… they certainly could not each of them make twenty, perhaps not one pin a day. –AS, 1776

17. Increasing and then Decreasing Returns

18. Figure 6 Big Bob’s Cost Curves
(b) Marginal- and Average-Cost Curves
Costs
$3.00
2.50 MC
2.00
1.50
ATC
AVC
1.00
0.50
AFC 2 4 6 8 10 12 14
Quantity of Output (bagels per hour)
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19. Short and Long Runs Short: plant & equipment fixed.
Long: time enough for plant & equipment to be adjusted

20. Figure 7 Average Total Cost in the Short and Long Run
ATC
in short
run with
small factory
ATC
in short
run with
medium factory
ATC
in short
run with
large factory
Cost
ATC
in long run
Economies of
scale
Diseconomies of
scale
1,200
$12,000
1,000
10,000
Constant
returns to
scale
Quantity of
Cars per Day
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