Chapter 8
Costs of Production
Principles of Economics
by Fred M Gottheil
PowerPoint Slides prepared by Ken
Long
©1999 South-Western College Publishing
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What is a Production
Function?
A relationship
between inputs and
outputs
2
Q = f(L, C)
• Q = output
• L = labor input
• C = capital input
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What is the Short Run?
A time in which producers
can change some, but not
all of its resources
(inputs)
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What is the Long Run?
The time period in which
producers can change
any of its resources
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Example of a production function
TP = total product or output, MP =
marginal product
Labor
TP
0
1
2
3
4
5
6
7
8
MP
0
10
24
36
46
52
54
54
52
10
14
12
10
6
2
0
-2
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Total and marginal product curves
Total Product
Labor
Marginal Product
Labor
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Marginal Product
III
I
II
Labor
•Zone 1, increasing MP
•Zone 3, negative MP
•Zone 2, diminishing MP
•Can you see why the firm is likely to end up operating
in zone 2?
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What is the Law of
Diminishing Returns?
As more units of a
resource are added to
production output will
increase by smaller
amounts, ceteris paribus
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Short Run Costs of
Production
Total costs = Total Fixed
costs + Total Variable
costs
TC = TFC + TVC
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What is a Fixed Cost?
Cost to a firm that does
not vary with the quantity
of goods produced
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What are examples of
Fixed Costs?
• rent or mortgage
• loan payments
• certain salaries
• a part of utilities
• property taxes
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What are some other
names for Fixed Cost?
Sunk and Historical
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What is a Variable Cost?
Cost that varies with the
quantity of goods produced
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What are examples of
Variable Costs?
• worker’s wages
• raw materials
• some utilities
• some taxes
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What is
Total Variable Cost?
The sum of specific
variable costs in the
firm’s cost structure
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Total Fixed cost curve
TFC
Q
0
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Total Variable Cost Curve
TVC
Q
0
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Total Costs, Sum of Variable and
Fixed Cost
TC
TC
TVC
TFC
Q
0
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What is
Average Total Cost?
Total cost divided by
the quantity of
goods produced
ATC = TC/Q
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What is
Average Fixed Cost?
Total fixed cost divided
by the quantity of
goods produced
AFC = TFC/Q
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What is
Average Variable Cost?
Total variable cost
divided by the quantity
of goods produced
AVC = TVC/Q
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$
Ave. Fixed Costs
ATC
AVC
Q
23
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What is
Marginal Cost?
The change in total cost
generated by a change
in the quantity of a
good produced
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MC =
TC
Q
=
TVC
Q
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Why does MC = ATC at
minimum ATC?
If the margin is above the
average, the average increases
If the margin is below the
average, the average decrease
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$
Ave. Fixed Costs
MC
ATC
AVC
Q
2
7
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What are
Economies of Scale?
When a firm increases
resources in the long run
and efficiency increases
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What can cause
economies of scale?
• Increased specialization
• Specialized capital
equipment
• Dimensional factors
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What are
Diseconomies of Scale?
When a company
increases resources in
the long run and
efficiency decreases
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What can cause
diseconomies of scale?
• Limits to efficient
functioning of
management
• Layers of bureacracy
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Costs in the Long Run and
Economies of Scale
AC
Economies
of scale
Diseconomies
of scale
Output
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The Family of Short-Run Average
Cost Curves
$
ATC1
ATC2
ATC3
Long-run
average cost
Output per period
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What are different views
concerning downsizing?
http://www.visioncoach.com
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What is
Labor Productivity?
The output per
laborer per hour
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Which is cheaper to pay
$10 an hr. to a U.S.
worker or $1 an hour to a
foreign worker?
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The $10 an hour may be
cheaper if the U.S. worker
is a lot more productive
than the foreign worker
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•
•
•
•
•
•
•
•
What is a Fixed Cost?
What is a Variable Cost?
What are Total Costs?
What is Marginal Cost?
What is the Short Run?
What is the Long Run?
What are Economies of Scale?
What are Diseconomies of Scale?
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END
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