Chapter 13: The Costs of Production

The goal of a firm is to

maximize profit.

Total revenue

The amount a firm receives for the sale of its output. Calculated by P * Q

Total cost

The market value of the inputs a firm uses in production.

Profit

Total revenue minus total cost

Costs of producing an item must include all the

opportunity costs of inputs which include both explicit and explicit costs, both examined by economists.

Explicit costs

Input costs that require an outlay of money by the firm. Accountants focus only on this.

Implicit costs

Input costs that do not require an outlay of money by the firm.

Economic profit

Total revenue minus total cost, including explicit & implicit costs.

Accounting profit

Total revenue minus total explicit cost.

If implicit costs > 0,

accounting profit > economic profit.

Production function

The relationship between quantity of inputs used to make a good and the quantity of output of that good.

Marginal product

The increase in output that arises from an additional unit of input. Decreases as amount of labor used increases.

Diminishing marginal product

The property whereby the marginal product of an input declines as the quantity of the input increases.

Total cost is equal to

fixed cost plus variable cost.

Fixed costs

Costs that do not vary with the quantity of output produced.

Variable costs

Costs that do vary with the quantity of output produced.

Average Total Cost (ATC)

Total cost divided by the quantity of output produced; the sum of average fixed cost and average variable cost.

Average Fixed Cost (AFC)

Fixed cost divided by the quantity of output.

Average Variable Cost (AVC)

Variable costs divided by the quantity of output.

Marginal cost

The increase in total cost that arises from an extra unit of production.

Rising marginal costs occurs due to

diminishing marginal product.

As output expands,

AFC declines and AVC typically increases, which pulls down ATC.

Efficient scale

The quantity of output that minimizes average total cost.

When MC < ATC,

ATC is falling.

When MC > ATC,

ATC is rising.

Economies of scale

The property whereby long-run average total cost falls as the quantity of output increases.

Diseconomies of scale

The property whereby long-run average total cost rises as the quantity of output increases.

Constant returns to scale

The property whereby long-run average total cost stays the same as the quantity of output changes.