Production & Cost in the Firm
ECO 2013
Chapter 7
Created: M. Mari
Fall 2007
Economic Costs
• Costs exists because resources are
scarce and have alternative uses
• When society uses a combination of
resources to produce a particular
product, it foregoes all alternative
opportunities to use those resources
for other purposes.
• The measure of the economic cost or
the opportunity cost of any resource
used to produce a good is the value
or worth the resource would have in
its best alternative.
Economic Costs
• (opportunity costs) are those
payments a firm must make or
income it must provide to resource
suppliers to attract the resources
away from alternative production.
Costs
• Two types of costs
– Explicit
– Implicit
• Total costs = Explicit Costs + Implicit Costs
Explicit Costs
•are monetary
payments to nonowners of the firm for
the resources they
supply.
–Rent
–Labor
–Materials
–Utilities
Implicit Costs
•costs of self-owned, self-employed resources.
–Salary of owner not taken
–Capital invested by owners
–Foregone rent, interest, wages
•Not seen in accounting profit analysis
Profits
• Accounting profit
– A firm’s total revenue minus its explicit
costs
– Total revenue – explicit costs
• Economic profit
– A firm’s total revenue minus explicit and
implicit costs
– Earn more than expected
– Normal profit
• The accounting profit earned when all
resources earn their opportunity costs
• What you expect to earn
Production in the Short Run
• Long run
– A period during which all resources
under the firm’s control are variable
• Short run
– A period during at least one of a firm’s
resources is fixed
Relationships
• A firm’s costs of producing a specific
output depend not only on the price
of needed resources but also on the
quantities of resources needed to
produce that output.
• Resource supply and demand
determine the resource prices
• The technological aspects of
production specifically the
relationship between inputs and
outputs, determine the quantity of
resources needed.
Law of Diminishing Marginal
Returns
• Total product
– The total output produced by a firm
• Production function
– The relationship between the amount of
resources employed and a firm’s total
product
• Marginal product
– The change in total product that occurs
when the sue of a particular resource
increases by one unit
Marginal Returns
• Law of diminishing marginal returns
– As more of a variable resource is added
to a given amount of a fixed resource,
marginal product eventually declines
and could become negative
Graphical
Total product
Total product
Workers per day
Diminishing
but positive
M
P
Increasing
Negative marginal
returns
Costs in the Short run
•Fixed costs
–Any production cost that is independent of the
firm’s rate of output
•Depreciation on building
•Insurance
•Property taxes
•Variable costs
–An production cost that changes as the rate of
output changes
–Labor
–Materials
–utilities
Formula
Total Costs = Fixed Costs + Variable
Cost
Variable costs = Variable cost per unit x
units
At zero output then:
Total costs = Fixed costs
Formula
Average Fixed Costs (AFC) = Total Fixed Costs
Output (Q)
Average Variable Costs (AVC) = Total Variable Costs
Output (Q)
Average Total Costs (ATC) = Total Costs
Output (Q)
Marginal Costs = Change in total cost
Change in quantity
Chart
Tons per
day
Fixed
Costs
Workers
per day
Variable
costs
Total
Costs
Marginal
Costs
0
$200
0
0
$200
-
2
$200
1
$100
$300
$50
5
$200
2
$200
$400
$33.33
9
$200
3
$300
$500
$25
12
$200
4
$400
$600
$33.33
14
$200
5
$500
$700
$50
15
$200
6
$600
$800
$100
Curves
Total cost
Variable costs
$200
0
Fixed Costs
Tons per day
Curves
Marginal cost
Costs in the Long Run
• No fixed costs exists
• Can increase facility size
• Long run Average cost curve
– A curve that indicates the lowest
average cost of production at each rate
of output when the size or scale of the
firm varies
Economies of Scale
• Explain the downward sloping part
of the long run ATC curve
• Economies of mass production
• Capital intensive firms
• As plant size increases, a number of
factors will for a time lead to lower
average costs of production
• Labor specialization
• Managerial specialization
• Efficient capital
Diseconomies of Scale
• Caused by the difficulty of efficiently
controlling and coordinating a firm’s
operations, as it becomes a largescale producer.
• Alienation of workers
Constant Returns to Scale
• Long-run average costs do not
change as output changes.
•
Example: textbooks