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