Chapter 8: The Costs of Production
- Opportunity cost - Value of resource in best alternative use
- Explicit costs - Monetary payments for use of resources owned by others
- Implicit costs - Opportunity costs of using self-owned/self-employed resources; monetary payments that resources could’ve earned in best alternative use
- Accounting profit ignores implicit costs + overstates economic success
- Normal profit - Cost of doing business
- Economic costs = Explicit costs + implicit costs
- Economic profit = Total revenue - economic costs
- Short run - Period too brief for firm to alter plant capacity, but long enough to change resources like hourly labor, raw materials, etc.
- Long run - Period long enough to change quantities of all resources it employs, including plant capacity
- Total product (TP) - Total output of good/service produced
- Marginal product (MP) - Extra output of product with adding unit of variable resource
* Slope of total product curve - Average product (AP) - Output per unit of labor input
- Law of diminishing returns - Successive units of variable resource added to fixed resource → Marginal product for each additional unit of variable resource will decline
- Marginal product greater than average product → Average product increasing
- Fixed costs - Aren’t affected by changes in output
* Must be paid even if output is zero - Variable costs - Costs that change w/ level of output
- Total cost = Total fixed costs + total variable costs
- Average fixed cost (AFC) = Total fixed cost / output
- Average variable cost (AVC) = Total variable cost / output
- Average total cost (ATC) = Total cost / output
- Marginal cost - Extra cost of producing one more unit of output
* Graph’s shape is consequence of law of diminishing returns - Marginal cost less than average total cost → ATC falls
- Changes in resource prices or technology → Costs change and cost curves shift
* Discovery of new technology → Productivity of all inputs increase
- Economies of scale - Down-sloping part of long run ATC curve; as plant size increases, a number of factors will for a time lead to lower average costs of production
* Labor specialization - Increased specialization in the
use of labor becomes more achievable as a plant
increases in size
* Managerial specialization - Large-scale production
also means better use of, and greater specialization in,
management
* Efficient capital - Large-scale producers have a high volume of production, resulting in effective use of equipment - Diseconomies of scale - Difficulty of efficiently controlling and coordinating a firm’s operations as it becomes a large-scale producer
* Expansion of management hierarchy → Communication + cooperation problems - Constant returns to scale - Long run average cost doesn’t change
- Minimum efficient scale (MES) - Lowest level of output at which a firm can minimize long-run average costs
- Natural monopoly - Average total cost is minimized when only one firm produces the particular good or service
