Chapter 13 - The Costs of Production

13-1 What Are Costs?

Total Revenue, Total Cost, and Profit

• Total revenue: the amount a firm receives for the sale of its output.
• Total cost: the market value of the inputs a firm uses in production.
• Profit: total revenue minus total cost.

Costs as Opportunity Costs

• Explicit costs: input costs that require an outlay of money by the firm.
• Implicit costs: input costs that do not require an outlay of money by the firm.

The Cost of Capital as an Opportunity Cost

• Accountants and economists think differently.

Economic Profit versus Accounting Profit

• Economic profit: total revenue minus total cost, including both explicit and implicit costs.
• Accounting profit: total revenue minus total explicit cost.

13-2 Production and Costs

The Production Function

• Production function: the relationship between the number 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.
• Diminishing marginal product: the property whereby the marginal product of an input declines as the quantity of the input increases.

From the Production Function to the Total-Cost Curve

• When the quantity of a good is rapidly produced in large amounts, the total-cost curve is relatively steep.

13-3 The Various Measures of Cost

Fixed and Variable Costs

• Fixed costs: costs that do not vary with the quantity of output produced.
• Variable costs: costs that vary with the quantity of output produced.

Average and Marginal Cost

• Average total cost: total cost divided by the quantity of output.
• Average fixed cost: fixed cost divided by the quantity of output.
• Average variable cost: variable cost divided by the quantity of output.
• Marginal cost: the increase in total cost that arises from an extra unit of production.
• Average total cost = total cost / quantity; or ATC = TC/Q.
• Marginal cost = change in total cost / change in quantity; or MC = ∆TC/∆Q.
• The greek letter, ∆, or delta, represents the change in a variable.

Cost Curves and Their Shapes

• Efficient scale: the quantity of output that minimizes average total cost.

Typical Cost Curves

• The key features included in cost curves are useful in analyzing firm behavior.
• A U-shaped average-total-cost curve is caused by a combination of increasing than diminishing marginal product.

13-4 The Relationship Between Short-Run and Long-Run Average Total Cost

• A graph with a longer-run average-total-cost curve is flatter than a shorter-run average-total-cost curve.
• In the long run, firms are shown to be quite flexible.

Economies and Diseconomies of Scale

• Economies of scale: the property whereby long-run average total cost falls as the number of output increases.
• Diseconomies of scale: the property whereby long-run average total cost rises as the number of output increases.
• Constant returns to scale: the property whereby long-run average total cost stays the same as the number of output changes.

13-5 Conclusion

• Firm cost curves don't show what decisions the firm will make but they help determine that decision.

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