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

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• 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

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• Law of diminishing returns - Successive units of variable resource added to fixed resource → Marginal product for each additional unit of variable resource will decline

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• 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

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• 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

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• Changes in resource prices or technology → Costs change and cost curves shift
  • Discovery of new technology → Productivity of all inputs increase

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• 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

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• 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

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