1. Copyright©2004 South-Western Mod 55 The Costs of Production

2. Copyright © 2004 South-Western/ First—we review: Review the Production Function Curve Remember: The Production Function curve shows the relationship between Q of input and Q of output. Notice the two axis. The Production Function Curve will show diminishing returns. Notice that the X axis is Q of input and the Y axis is Q of output.

3. Copyright © 2004 South-Western/ Review the MPL Curve Remember: The MPL curve shows the relationship between Q of input and the Marginal Product (output) The MPL Curve will show the property whereby the marginal product of an input declines as the quantity of the input increases

4. Copyright © 2004 South-Western/ Big Bob’s Cost Curves

5. Copyright © 2004 South-Western/ From the Production Function to the Total-Cost Curve The total-cost curve essentially flips the Production Function curve on its side—the X axis is now Q of output and the Y axis is Cost. It shows the relationship between the quantity a firm can produce and its costs, which will then be picked apart to determine quantity of production decisions.

6. Big Bob’s Total Cost Curve Copyright © 2004 South-Western Total-Cost Curve $18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 Quantity of Output (bagels per hour) TC 4268141210 2.00 Total Cost 0

7. Copyright © 2004 South-Western/ Total Costs Total Fixed Costs (TFC) Total Variable Costs (TVC) Total Costs (TC) TC = TFC + TVC

8. Copyright © 2004 South-Western/ Big Bob’s Cost Curves

9. Copyright © 2004 South-Western/ Average Costs Average costs can be determined by dividing the firm’s costs by the quantity of output it produces. The average cost is the cost of each typical unit of product. We use average costs b/c they help us to see costs per unit of the product, which will help us along towards making decisions about quantity of production.

10. Copyright © 2004 South-Western/ Average Costs: Fixed, Variable, & Total Costs Average Costs Average Fixed Costs (AFC) Average Variable Costs (AVC) Average Total Costs (ATC) ATC = AFC + AVC

11. Copyright © 2004 South-Western/ Average Cost Formulas

12. Copyright © 2004 South-Western/ Big Bob’s Cost Curves Copyright © 2004 South-Western Average-Cost Curves Quantity of Output (bagels per hour) Costs $3.00 2.50 2.00 1.50 1.00 0.50 04268141210 ATC AVC AFC

13. Copyright © 2004 South-Western/ Big Bob’s Cost Curves

14. Copyright © 2004 South-Western/ Marginal Cost Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production. Marginal cost helps answer the following question: How much does it cost to produce an additional unit of output?

15. Copyright © 2004 South-Western/ Marginal Cost

16. Big Bob’s Cost Curves Copyright © 2004 South-Western Marginal- and Average-Cost Curves Quantity of Output (bagels per hour) Costs $3.00 2.50 2.00 1.50 1.00 0.50 04268141210 MC ATC AVC AFC

17. Copyright © 2004 South-Western/ Further Understanding of “Marginal” with Costs GPA example Factory Example

18. Copyright © 2004 South-Western/ Three Important Properties of Cost Curves The average-total and average-variable Cost Curves are U-shaped The first part of the “U” shows a downward slope and is called the Spreading Effect—it is the dropping of costs due to “spreading out” of the average fixed and variable costs across more and more production AND the benefit of more MPL

19. Copyright © 2004 South-Western/ Three Important Properties of Cost Curves The average-total and average-variable Cost Curves are U-shaped. The second part of the “U” shows an upward slope and is called the Diminishing Returns Effect—it is rising of costs due to the loss of that initial efficiency from spreading of costs and MPL and the increased costs as output rises

20. Copyright © 2004 South-Western/ Three Important Properties of Cost Curves The Marginal Cost Curve is swoosh-shaped The “dip” of the swoosh shows a drop at first due to increasing MPL when variable inputs are first added (i.e., first additions of labor) The “rise” of the Swoosh shows the rise what occurs with the increasing quantity of output and MPL

21. Copyright © 2004 South-Western/ Classic Cost Curves

22. Copyright © 2004 South-Western/ Minimum-Cost Output Level efficient scaleThe marginal-cost curve crosses the average- total-cost curve at the “efficient scale.” Efficient scale is the QUANTITY that minimizes average total cost. It is the QUANTITY where MC = ATC

23. Copyright © 2004 South-Western/ Classic Cost Curves A NIKE SWOOSH and 2 SMILES!! Efficient Scale Q

24. Copyright © 2004 South-Western/ Classic Cost Curves A NIKE SWOOSH and 2 SMILES!! A NIKE SWOOSH & TWO SMILES Efficient Scale Q