The Cost Function
Chapter 13
The Production Function
TP
Shape of product curves determines
the costs curves for a business
AP
MP
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)
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
Economists vs. Accountants
How an Economist
Views a Firm
Economic
Profit
$825
Total
Revenue
How an Accountant
Views a Firm
1) Value of your time
2) Loss of interest
income on money invested
3) Etc….
Implicit
Costs
$75
$900
Total
opportunity
costs
$1,000
Explicit
Costs
$100
Accounting
Profit
Anything paid for
in dollars
Total
Revenue
$1,000
Explicit
Costs
$100
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?
Costs of Production
Variable
Costs
Fixed
Costs
Total
Cost
FC + VC = TC
Fixed Costs (FC)
Variable Costs (VC)
Total Costs (TC)
Marginal Costs = ∆ Total Cost
Total Cost @ 3 units:
$4.50
Total Cost @ 4 units:
$5.40
Marginal Cost of 4th unit
= $0.90
Worksheet:
The Cost Function