1. The Cost Function
Chapter 13

2. The Production FunctionTP MP AP
Shape of product curves determines the costs curves for a business

3. Opportunity Costs
A firm’s cost of production must include all opportunity costs
Both explicit & implicit
Explicit costs- input costs that require a direct outlay of money
Example: attending college => tuition, books, etc….
Implicit costs- input costs that do not require an outlay of money
Example: attending college => can’t work (loss of income)

4. Economic Profit vs. Accounting Profit
Economic profit = total revenue - total costs
both explicit & implicit costs
Accounting profit = total revenue - explicit costs
no implicit costs!
Economic profit is smaller than accounting profit
Firms maximize economic profit
All cost curves include both implicit & explicit costs

5. Economists vs. Accountants
How an Economist
How an Accountant
Views a Firm
Views a Firm
Total
Revenue
$1,000
Economic
Profit
$825
1) Value of your time
2) Loss of interest
income on money invested
3) Etc….
Accounting
Profit
$900
Total
Revenue
$1,000
Implicit
Costs
$75
Total
opportunity
costs
Explicit
Costs
$100
Explicit
Costs
$100
Anything paid for
in dollars

6. Costs of Production
Fixed costs - do not change with quantity of output
Rent on factory, utilities, insurance, etc…. (they are sunk!)
Variable costs - change with quantity of output
# workers, qty of steel, other inputs etc…
Marginal cost measures the increase in total cost that arises from an extra unit of production
How much does it cost to produce one additional unit of output?

7. Costs of Production FC + VC = TC Variable Costs Fixed Costs Total Cost
Fixed Costs (FC)
Variable Costs (VC)
Total Costs (TC)

8. Marginal Costs = ∆ Total Cost
Total 3 units:
$4.50
Total 4 units:
$5.40
Marginal Cost of 4th unit
= $0.90

9. Worksheet: The Cost Function