1. The Costs of Production Chapter 13 Copyright © 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

2. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Objective The economic goal of the firm is to maximize profits.

3. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Firm’s Profit Profit is the firm’s total revenue minus its total cost. Profit = Total revenue - Total cost Total Cost includes all of the opportunity costs of production

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. What happens to profit though as you keep on adding workers? Additional input Additional output = Marginal product

6. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Diminishing Marginal Product u Diminishing marginal product is the property whereby the marginal product of an input declines as the quantity of the input increases. u Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment.

7. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Your Journal Question n You have just been given 10 acres of land. n The land is of varying quality. n The amount of land remains fixed. n What will happen to your yield as you keep on adding workers? n Can you write down an example of diminishing returns from your experience?

8. 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

9. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Fixed and Variable Costs u Fixed costs are those costs that do not vary with the quantity of output produced. u Variable costs are those costs that do change as the firm alters the quantity of output produced. u Short Run vs. Long Run Costs

10. 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

11. 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

12. 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

13. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. n Relation Between Production Function and Total Cost. n Dimininish ing Returns

14. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Average Costs u Average costs can be determined by dividing the firm’s costs by the quantity of output produced. u The average cost is the cost of each typical unit of product.

15. 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

16. 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

17. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Marginal Cost u Marginal cost (MC) measures the amount total cost rises when the firm increases production by one unit.  Marginal cost helps answer the following question: u How much does it cost to produce an additional unit of output?

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

19. 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

20. 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

21. 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. uLaw of Diminishing Marginal Returns 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. u Work on homework assignment!

22. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Costs in the Long Run u For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered. u In the short run some costs are fixed. u In the long run fixed costs become variable costs.

23. 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

24. 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