Chapter 7: Production Costs
Chapter 7: Production Costs
Total fixed cost (tfc)
• Costs that do not change no matter how much you produce
• Costs stay the same even if you produce zero
Ex: rent, electricity bill
Variable cost
• Cost that change with the level of production
• These costs increase as you produce more units
• When summed up to other units, it contributes to total variable cost
Ex: hourly wages for workers, costs of raw materials
Total product
• The total amount of goods or services provided
• This shows the output level of the production process
Ex: if a factory makes 100 widgets a day, the total product Is 100 widgets.
Total variable cost
• The total of all variable costs for a given level of production
• Helps understand the costs that increase with production and impacts pricing and profit calculations
• Part of the total cost
Ex: if producing 100 widgets costs $500 in materials and $300 in labor, the total variable cost is $800.
Total cost
• The sum of the total fixed cost and total variable cost
• TFC+TVC=TC
• Represents the complete cost of production, including both fixed and variable costs.
Why AVC decreases then increases
decrease
• Economies of scale: When production starts, increasing output often leads to more efficient use of resources and lower variable costs per unit.
increase
• Diseconomies of scale: after a certain point, increasing production can lead to inefficiencies, causing variable cost per unit to rise
Ex: workers less productive because overworked, machines needing more maintenance if overused
• Analogy: when u start to bake cookies and get good at it, you buy ingredients in bulk but eventually, you might run into problems like your oven breaking down or getting tired and making mistakes, so you increase the cost of cookies.
Why AFC Decreases
• As you produce more units, the fixed cost Is spread out more units, making it cheaper
Why ATC decreases then increases
• Increasing due to rising variable costs, therefore making the average variable costs to increase (AVC)
• Analogy: the cost of running a bakery (TC) per cookie, at first, the rent (FC) and ingredients (VC) costs decrease as you bake more cookies but eventually, increasing production will increase ingredient costs, raising cost of cookies.
Law of diminishing marginal returns: as you add additional resources (workers) to fixed resources (machines), each additional unit will produce a less output
Ex: if you add one worker to your kitchen and they use that machinery and space, adding a second worker would increase efficiency if they are assigned a different job. But, as you keep adding more and more workers, they begin to bump into each other or wait their turn to use the oven. Each worker adds less and less to the total number pizzas made due to the fixed kitchen space and oven.
Marginal-Average Rule:
the relationship between marginal costs and average costs
short-term impacts of adding each unit of input on production costs
It helps firms understand how adding one more unit of input affects the average cost or benefit in the short term.
Marginal cost: the cost of producing one additional unit of output
Average cost: total cost divided by the number out output produced
When MC is less than AC, the AC decreases
Ex: if your current average is 85 and you get an 80 on your next test, your average will decrease
When MC is greater than AC, AC increases
Ex: if your current average grade is 85% and you get an 90 on your next test, your average will increase
When mc is equal to ac, ac remains constant
Ex: if your current average is 80 and you get an 80 on your next test, your average will remain the same
Marginal Product:
focuses on how much more is produced with one additional input
Marginal-Average Rule: focus on how adding more unit of input affects average costs or average output
Returns to Scale:
How efficiently a firm uses inputs as it changes its production scales
Long-term efficiency gains or losses as inputs are adjusted
It looks at overall efficiency and productivity as a firm grows larger or smaller by adjusting its inputs like labor and capital.
• increasing returns to scale
o a bakery doubles its workforce by adding more input (workforce and ovens) and the output triples by producing 250 loaves
• constant returns to scale
o bakery double its input and the output also doubles
• decreasing returns to scale
o bakery double its inputs and outputs are less than double
how is it different from marginal-average rule?
Marginal average rule focuses on how additional inputs like a worker or oven increase or decrease production costs.