1. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Explaining Supply: The Costs of Production Law of Supply u Firms are willing to produce and sell more of a good when price is HIGH. Price received must cover costs. Law of increasing costs: u Unit costs rise with output.

2. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Objective: MAXIMIZE PROFIT n Profit = total revenue – total costs

3. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Costs as Opportunity Costs A firm’s cost of production includes all the opportunity costs it incurs, implicit costs as well as explicit costs.

4. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Economic Profit versus Accounting Profit Revenue Total opportunity costs How an Economist Views a Firm Explicit costs Economic profit Implicit costs Explicit costs Accounting profit How an Accountant Views a Firm Revenue

5. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Production Function and Total Cost

6. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Production Function... Output vs Input Quantity of Output (cookies per hour) 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 Number of Workers Hired 012345 Production function

7. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Marginal Product The marginal product of any input is the additional output obtained from an additional unit of the input. Additional input Additional output = Marginal product

8. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Diminishing Marginal Product Marginal product of an input declines as the quantity of the input increases. uAs more and more workers are hired at a firm, each additional worker adds less and less to output. uThe firm has a limited amount of equipment for the workers to work with.

9. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Diminishing Marginal Product u The slope of the production function measures the marginal product of an input. u When the marginal product declines, the production function becomes flatter.

10. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Production Function and Total Cost Hungry Helen’s Cookie Factory

11. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Total-Cost Curve... Total Cost $80 70 60 50 40 30 20 10 Quantity of Output (cookies per hour) 0 20401401201008060 Total-cost curve

12. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Fixed, Variable, and Total Costs u Fixed costs are costs that do not change with output. u Variable costs are costs that do change with output. Total Cost = Fixed Cost + Variable Cost

13. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Family of Total Costs u Total Fixed Costs (TFC) u Total Variable Costs (TVC) u Total Costs (TC) TC = TFC + TVC

14. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Family of Total Costs QuantityTotal CostFixed CostVariable Cost 0$ 3.00 $ 0.00 13.303.000.30 23.803.000.80 34.503.001.50 45.403.002.40 56.503.003.50 67.803.004.80 79.303.006.30 811.003.008.00 912.903.009.90 1015.003.0012.00

15. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Average Costs u Average costs: costs divided by the quantity of output. u Average cost is the cost of each typical unit of product.

16. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Family of Average Costs u Average Fixed Costs (AFC) u Average Variable Costs (AVC) u Average Total Costs (ATC) ATC = AFC + AVC

17. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Family of Average Costs

18. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Family of Total Costs QuantityTotal CostFixed CostVariable Cost 0$ 3.00 $ 0.00 13.303.000.30 23.803.000.80 34.503.001.50 45.403.002.40 56.503.003.50 67.803.004.80 79.303.006.30 811.003.008.00 912.903.009.90 1015.003.0012.00

19. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. $3.00 Family of Average Costs QuantityAFCAVCATC 0——— 1$0.30$3.30 21.500.401.90 31.000.501.50 40.750.601.35 50.600.701.30 60.500.801.30 70.430.901.33 80.381.001.38 90.331.101.43 100.301.201.50

20. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Marginal Cost

21. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Marginal Cost

22. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Total-Cost Curve... $0.00 $2.00 $4.00 $6.00 $8.00 $10.00 $12.00 $14.00 $16.00 0 24681012 Quantity of Output (glasses of lemonade per hour) Total Cost Total-cost curve

23. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. ATC AVC MC Average-Cost and Marginal-Cost Curves... $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 0 24681012 Quantity of Output (glasses of lemonade per hour) Costs AFC

24. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost Curves and Their Shapes Marginal cost rises with the amount of output produced. u This reflects the property of diminishing marginal product.

25. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost Curves and Their Shapes $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 024681012 Quantity of Output (glasses of lemonade per hour) Costs MC

26. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost Curves and Their Shapes The average total-cost curve is often U- shaped. u At very low levels of output average total cost is high because fixed cost is spread over only a few units. u Average total cost declines as output increases. u But average total cost starts rising because average variable cost rises substantially.

27. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost Curves and Their Shapes The bottom of the U-shape occurs at the quantity that minimizes average total cost. This quantity is called the efficient scale of the firm.

28. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost Curves and Their Shapes $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 024681012 Quantity of Output (glasses of lemonade per hour) Total Costs ATC

29. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Relationship Between Marginal Cost and Average Total Cost u Whenever marginal cost is less than average total cost, average total cost is falling. u Whenever marginal cost is greater than average total cost, average total cost is rising.

30. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. MC ATC Relationship Between Marginal Cost and Average Total Cost $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 024681012 Quantity of Output (glasses of lemonade per hour) Costs

31. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Various Measures of Cost Big Bob’s Bagel Bin

32. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Big Bob’s Cost Curves... $0.00 $2.00 $4.00 $6.00 $8.00 $10.00 $12.00 $14.00 $16.00 $18.00 $20.00 0246810121416 Quantity of Output (bagels per hour) Total Cost Total Cost Curve

33. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. AFC AVC MC Big Bob’s Cost Curves... 0 0.5 1 1.5 2 2.5 3 3.5 0246810121416 Quantity of Output Costs ATC

34. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Three Important Properties of Cost Curves u Marginal cost eventually rises with the quantity of output. u The average-total-cost curve is U- shaped. u The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.

35. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Costs in the Long Run Many costs are fixed in the short run but variable in the long run. n A firm’s long-run cost curves differ from its short-run cost curves.

36. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Average Total Cost in the Short and Long Runs... Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory ATC in long run

37. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Economies and Diseconomies of Scale u Economies of scale occur when long-run average total cost declines as output increases. u Diseconomies of scale occur when long- run average total cost rises as output increases. u Constant returns to scale occur when long-run average total cost does not vary as output increases.

38. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Economies and Diseconomies of Scale Diseconomies of scale Quantity of Cars per Day 0 Average Total Cost ATC in long run Economies of scale Constant Returns to scale

39. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The goal of firms is to maximize profit, which equals total revenue minus total cost. u When analyzing a firm’s behavior, it is important to include all the opportunity costs of production. u Some opportunity costs are explicit while other opportunity costs are implicit.

40. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u A firm’s costs reflect its production process. u A typical firm’s production function gets flatter as the quantity of input increases, displaying the property of diminishing marginal product. u A firm’s total costs are divided between fixed and variable costs. Fixed costs don’t vary with quantities produced; variable costs do.

41. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Average total cost is total cost divided by the quantity of output. u Marginal cost is the amount by which total cost would rise if output were increased by one unit. u The marginal cost always rises with the quantity of output.

42. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The average-total-cost curve is U- shaped. u The marginal-cost curve always crosses the average-total-cost curve at the minimum of ATC. u A firm’s costs often depend on the time horizon being considered.

43. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Graphical Review

44. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Economic Profit versus Accounting Profit Revenue Total opportunity costs How an Economist Views a Firm Explicit costs Economic profit Implicit costs Explicit costs Accounting profit How an Accountant Views a Firm Revenue

45. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Production Function... Quantity of Output (cookies per hour) 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 Number of Workers Hired 012345 Production function

46. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Total-Cost Curve... Total Cost $80 70 60 50 40 30 20 10 Quantity of Output (cookies per hour) 0 20401401201008060 Total-cost curve

47. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Total-Cost Curve... $0.00 $2.00 $4.00 $6.00 $8.00 $10.00 $12.00 $14.00 $16.00 0 24681012 Quantity of Output (glasses of lemonade per hour) Total Cost Total-cost curve

48. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Average-Cost and Marginal-Cost Curves... ATC AVC MC $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 0 24681012 Quantity of Output (glasses of lemonade per hour) Costs AFC

49. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost Curves and Their Shapes $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 024681012 Quantity of Output (glasses of lemonade per hour) Costs MC

50. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost Curves and Their Shapes $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 024681012 Quantity of Output (glasses of lemonade per hour) Total Costs ATC

51. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Relationship Between Marginal Cost and Average Total Cost MC ATC $0.00 $0.50 $1.00 $1.50 $2.00 $2.50 $3.00 $3.50 024681012 Quantity of Output (glasses of lemonade per hour) Costs

52. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Big Bob’s Cost Curves... $0.00 $2.00 $4.00 $6.00 $8.00 $10.00 $12.00 $14.00 $16.00 $18.00 $20.00 0246810121416 Quantity of Output (bagels per hour) Total Cost Total Cost Curve

53. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Big Bob’s Cost Curves... AFC AVC MC 0 0.5 1 1.5 2 2.5 3 3.5 0246810121416 Quantity of Output Costs ATC

54. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Average Total Cost in the Short and Long Runs... Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory ATC in long run

55. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Economies and Diseconomies of Scale Diseconomies of scale Quantity of Cars per Day 0 Average Total Cost ATC in long run Economies of scale Constant Returns to scale