2025-02-14 01-22

Businesses and the Costs of Production

Learning Objectives

• LO8.1: Explain economic costs (explicit and implicit).

• LO8.2: Relate the law of diminishing returns to short-run production costs.

• LO8.3: Distinguish between fixed and variable costs, and among total, average, and marginal costs.

• LO8.4: Use economies of scale to link firm size and long-run average costs.

• LO8.5: Provide business examples of short-run costs, economies of scale, and minimum efficient scale (MES).

Chapter Focus

• Transition from consumer behavior to producer behavior in market economies, exploring concepts of production and costs.

• Discuss economic resources, monetary payments, and opportunity costs that contribute to a firm's costs of production.

Economic Costs (LO8.1)

• Economic Cost: Payment to obtain and retain resource services. Includes:

  • Explicit Costs: Monetary payments for resources (e.g., wages).

  • Implicit Costs: Opportunity costs of using resources already owned (e.g., forgoing wages from previous job).

Short-Run Production Costs (LO8.2)

• Law of Diminishing Returns: As variable resources are added to a fixed resource, the marginal product eventually declines.

• Total Product (TP): Total output of a good/service.

• Marginal Product (MP): Additional output from adding one more unit of a variable resource.

• Average Product (AP): Total product divided by the quantity of labor used.

Costs Distinctions (LO8.3)

• Fixed Costs: Do not vary with output (e.g., rent).

• Variable Costs: Vary with output level (e.g., labor, materials).

• Total Cost (TC): Sum of fixed and variable costs (TC = TFC + TVC).

• Average Fixed Cost (AFC): Declines as output increases.

• Average Variable Cost (AVC): U-shaped curve due to increasing then diminishing returns.

• Average Total Cost (ATC): Combination of AFC and AVC; U-shaped.

• Marginal Cost (MC): Additional cost of producing one more unit.

Long Run and Economies of Scale (LO8.4)

• In the long run, all resources are variable, and firms can adjust all inputs, including plant size.

• Long-run ATC Curve: U-shaped; economies of scale decrease costs with expanding plant sizes until diseconomies of scale cause rising average total costs.

Example of Economies of Scale

• Labor Specialization: Improved efficiency with larger plants.

• Managerial Specialization: Larger operations allow for specialized management roles, increasing productivity.

• Efficient Capital: Larger firms can afford specialized, expensive machinery, leading to lower costs.

Short-Run Costs and Market Examples (LO8.5)

• Rising gasoline prices can increase short-run variable costs for firms reliant on fuel (e.g., FedEx).

• Successful Start-ups: Firms like Starbucks reduce costs through economies of scale resulting from larger production.

• Minimum Efficient Scale (MES): Varies by industry; e.g., large aircraft manufacturing vs. small concrete plants.

Summary of Key Terms

• Economics Cost: Sum of explicit and implicit costs.

• MES: Level of output that minimizes long-run average costs.