COSTS OF
PRODUCTION
Economic Costs
• Equal to opportunity costs
• Explicit + implicit costs
• Explicit costs
• Monetary payments
• Implicit costs
• Value of next best use
• Self-owned resources (rent)
• Self-employed resources (labor)
8-2
Profit
• Accounting profit
• Total revenue less explicit cost
• Normal profit
• Equal to implicit cost
• Economic or pure profit
• Total revenue less economic cost
8-3
Profits Compared
Economic
Implicit Costs
(Including a
Normal Profit)
Explicit
Costs
Total Revenue
Economic
(Opportunity)
Costs
Economic
Profit
Accounting
Accounting
Profit
Accounting
Costs (Explicit
Costs Only)
8-4
Definition of the “Short-Run”
• We will look at both short-run and long-run
production costs.
• Short-run is NOT a set specific amount of
time.
• The short-run is a period in which at least one
resource is fixed.
– Plant capacity/size is NOT changeable
• In the long-run ALL resources are variable
– NO fixed resources
– Plant capacity/size is changeable
Today we will examine short-run costs
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Different Economic Costs
Total Costs
FC = Total Fixed Costs
VC = Total Variable Costs
TC = Total Costs
Per Unit Costs
AFC = Average Fixed Costs
AVC = Average Variable Costs
ATC = Average Total Costs
MC = Marginal Cost
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6
Fixed Costs:
Definitions
Costs for fixed resources that DON’T change
with the amount produced
Ex: Rent, Insurance, Managers Salaries, etc.
Average Fixed Costs = Fixed Costs
Quantity
Variable Costs:
Costs for variable resources that DO change as
more or less is produced
Ex: Raw Materials, Labor, Electricity, etc.
Variable Costs
Average Variable Costs =
Quantity
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Definitions
Total Cost:
Sum of Fixed and Variable Costs
Average Total Cost =
Total Costs
Quantity
Marginal Cost:
Additional costs of an additional output.
Ex: If the production of two more output
increases total cost from $100 to $120, the MC
$10
is _____.
Change in Total Costs
Marginal Cost =
Change in Quantity
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Calculating Costs
Output
Variable Fixed
Cost
Cost
0
1
2
3
4
5
6
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ACDC Leadership 2015
$0
$10
$17
$25
$40
$60
$110
Total
Cost
$10 $10
$10 $20
$10 $27
$10 $35
$10 $50
$10 $70
$10 $120
Marginal
Cost
$10
$7
$8
$15
$20
$50
Let’s go
column by
column…
9
Total Cost Curves
TC
Costs
FC + VC = TC
VC
Fixed Cost
$10
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ACDC Leadership 2015
FC
Quantity
10
Calculating Costs
Now Calculate:
ATC
AFC
AVC
11
Calculating Costs
Fill in the table
12
Calculating Costs
Output
Variable Fixed
Cost
Cost
0
1
2
3
4
5
6
$0
$10
$17
$25
$40
$60
$110
Total
Cost
$10 $10
$10 $20
$10 $27
$10 $35
$10 $50
$10 $70
$10 $120
Marginal
Cost
AVC AFC ATC
$10
$7
$8
$15
$20
$50
$10
$10
$20
$8.50
$5 $13.50
$8.33 $3.33 $11.66
$10 $2.50 $12.50
$12
$2
$14
$18.33 $1.67
$20
Notice any relationships between average costs?
-Shape of curves
-AVC + AFC = ATC
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Calculating Costs
AVC AFC ATC
$10
$10
$20
$8.50
$5 $13.50
$8.33 $3.33 $11.66
$10 $2.50 $12.50
$12
$2
$14
$18.33 $1.67
$20
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MC
ATC
Costs
$20
$18
$16
$14
$12
$10
$8
$6
$4
$2
AVC
ATC and AVC get
closer and closer but
NEVER touch
Average
Fixed Cost
AFC
1
2
3
4
5
6 Quantity
15
MC
ATC
Costs
$20
$18
$16
$14
$12
$10
$8
$6
$4
$2
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ACDC Leadership 2015
AVC
Show TC, VC,
and FC of the 5th
Unit
AFC
1
2
3
4
5
6 Quantity
16
Practice
17
2008 Audit Exam
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ACDC Leadership 2015
1.
2.
Costs
Why does marginal cost always go
down then up?
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ACDC Leadership 2015
MC
Quantity
20
Relationship between Production and Cost
Output
As more workers are hired, their
marginal product increases and
then eventually decreases
because of the law of
diminishing marginal returns
MP
Costs
Quantity of labor
The additional costs (MC) of the
units they produce fall when MP
MC
goes up, but eventually increase
as additional workers produce
less and less output
MP and MC are mirror
images of each other
Quantity of output
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Graphical Relationships
Average Product and
Marginal Product
Production Curves
AP
MP
Quantity of Labor
MC
Cost (Dollars)
AVC
Cost Curves
Quantity of Output
8-22
Costs
Relationship between Production and Cost
Why does ATC go down
MC
then
up?
ATC
Quantity
•When the marginal cost is
below the average, it pulls
the average down.
•When the marginal cost is
above the average, it pulls
the average up.
MC intersects the ATC curve at ATC’s lowest point
Example:
•The average income in the room is $50,000.
•An additional (marginal) person enters the room: Bill Gates.
•If the marginal is greater than the average it pulls it up.
•Notice that MC can increase but still pull down the average.
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23
2008 Audit Question 23
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ACDC Leadership 2015
2010 Question 18
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ACDC Leadership 2015
When in
doubt, graph
it out
Costs
MC
ATC
$12
AVC
$10
$8
AFC
$2
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ACDC Leadership 2015
100
Quantity
1.
2.
Shifting Cost
Curves
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Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
3
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
What if Fixed
Costs increase to
$200
29
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
30
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
31
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Which Per Unit Cost Curves Change?
32
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
ONLY AFC and ATC Increase!
33
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
200
110
8
100
58
7
66.6 30.3
6.5
50
31.5
6
40
26
6
33.3 22.67
6.6
28.6 20.9
ONLY AFC and ATC Increase!
34
Shifting Costs Curves
If fixed costs change ONLY AFC and ATC Change!
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
200
200
200
200
200
200
200
200
TC
200
210
216
221
226
230
236
246
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
200
210
8
100
108
7
66.6 73.6
6.5
50
56.5
6
40
46
6
33.3 39.3
6.6
28.6 35.2
MC and AVC DON’T change!
35
Shift from an increase in a Fixed Cost
MC
Costs (dollars)
ATC1
ATC
AVC
AFC1
AFC
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ACDC Leadership 2015
Quantity
36
Shift from an increase in a Fixed Cost
MC
Costs (dollars)
ATC1
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ACDC Leadership 2015
AVC
AFC1
Quantity
37
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
What if the cost for
variable resources
increase
38
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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ACDC Leadership 2015
VC
0
10
16
21
26
30
36
46
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
39
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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ACDC Leadership 2015
VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
110
116
121
126
130
136
146
MC
10
6
5
5
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
40
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
10
6
5
3
4
6
10
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
Which Per Unit Cost Curves Change?
41
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
11
7
6
6
5
8
12
AVC AFC ATC
10
100
110
8
50
58
7
33.3 30.3
6.5
25
31.5
6
20
26
6
16.67 22.67
6.6
14.3 20.9
MC, AVC, and ATC Change!
42
Shifting Costs Curves
TP
0
1
2
3
4
5
6
7
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VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
11
7
6
6
5
8
12
AVC AFC ATC
11
100
110
9
50
58
8
33.3 30.3
7.5
25
31.5
7
20
26
7.16 16.67 22.67
7.8
14.3 20.9
MC, AVC, and ATC Change!
43
Shifting Costs Curves
If variable costs change MC, AVC, and ATC Change!
TP
0
1
2
3
4
5
6
7
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VC
0
11
18
24
30
35
43
55
FC
100
100
100
100
100
100
100
100
TC
100
111
118
124
130
135
143
155
MC
11
7
6
6
5
8
12
AVC AFC ATC
11
100
111
9
50
59
8
33.3 41.3
7.5
25
32.5
7
20
27
7.16 16.67 23.83
7.8
14.3 22.1
44
Shift from an increase in a Variable Costs
MC1
Costs (dollars)
MC
ATC1
AVC1
ATC
AVC
AFC
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Quantity
45
Shift from an increase in a Variable Costs
MC1
Costs (dollars)
ATC1
AVC1
AFC
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ACDC Leadership 2015
Quantity
46
Shifts in Cost Curves
• Practice: Which curves shift and how?
– Decrease in union wage requirements?
• AVC, ATC, MC shift DOWN
– Increase in rent?
• AFC, ATC, shift UP
– Increase in cost of materials?
• AVC, ATC, MC shift UP
– More efficient production technology is
discovered?
• AVC, ATC, MC shift DOWN