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Microeconomics Lecture 13
!
The Costs of Production
Key Termstotal cost profit explicit costs implicit costs economic profit accounting profit production function marginal product diminishing marginal product
fixed costs variable costs average total costs average fixed costs average variable costs marginal costs efficient scale economies of scale diseconomies of scale constant returns to scale
Riyadh Pizza Company
Total Cost TC
Total Cost TC
The market value of all of the inputs a
firm uses in production
Total Revenue TR
Total Revenue TR
Price x Quantity !
TR = P x Q
Profit PR
Profit PR
Total Revenue minus Total Cost
!
PR = TR - TC
Production Function
Production Function
The relationship between inputs and
outputs
Marginal Product
Marginal Product
Additional output of a unit of input
Diminishing Marginal Product
Diminishing Marginal Product
Marginal product declines as input
increases
Fixed Costs FC
Fixed Costs FC
Costs that do not vary with output
Variable Costs VC
Variable Costs VC
Costs that do vary with output
Total Costs TC
Total Costs TC
Fixed costs plus variable costs
!
TC = FC + VC
Average Total Costs ATC
Average Total Costs ATC
Total costs divided by quantity of output
ATC = TC ÷ Q
Average Fixed Costs AFC
Average Fixed Costs AFC
Fixed costs divided by quantity of output
AFC = FC ÷ Q
Average Variable Costs AVC
Average Variable Costs AVC
Variable costs divided by quantity
of output AVC = VC ÷ Q
Marginal Cost MC
Marginal Cost MC
The increase in total cost for the next
unit MC = ∆TC ÷ ∆Q
Q0
1
2
3
4
5
6
7
8
9
10
Q0
1
2
3
4
5
6
7
8
9
10
Fixed Cost FC100
100
100
100
100
100
100
100
100
100
100
Q0
1
2
3
4
5
6
7
8
9
10
Fixed Cost FC100
100
100
100
100
100
100
100
100
100
100
Variable Cost VC
20
39
59
84
120
160
212
270
340
420
Q0
1
2
3
4
5
6
7
8
9
10
Fixed Cost FC100
100
100
100
100
100
100
100
100
100
100
Variable Cost VC
20
39
59
84
120
160
212
270
340
420
Total Cost TC
FC + VC100
120
139
159
184
220
260
312
370
440
520
Q0
1
2
3
4
5
6
7
8
9
10
Fixed Cost FC100
100
100
100
100
100
100
100
100
100
100
Variable Cost VC
20
39
59
84
120
160
212
270
340
420
Total Cost TC
FC + VC100
120
139
159
184
220
260
312
370
440
520
Average Fixed Cost AFC
FC ÷ Q
100
50
33
25
20
17
14
13
11
10
Q0
1
2
3
4
5
6
7
8
9
10
Fixed Cost FC100
100
100
100
100
100
100
100
100
100
100
Variable Cost VC
20
39
59
84
120
160
212
270
340
420
Total Cost TC
FC + VC100
120
139
159
184
220
260
312
370
440
520
Average Fixed Cost AFC
FC ÷ Q
100
50
33
25
20
17
14
13
11
10
Average Variable
Cost AVC
VC ÷ Q
20.0
19.5
19.7
21.0
24.0
26.7
30.3
33.8
37.8
42.0
Q0
1
2
3
4
5
6
7
8
9
10
Fixed Cost FC100
100
100
100
100
100
100
100
100
100
100
Variable Cost VC
20
39
59
84
120
160
212
270
340
420
Total Cost TC
FC + VC100
120
139
159
184
220
260
312
370
440
520
Average Fixed Cost AFC
FC ÷ Q
100
50
33
25
20
17
14
13
11
10
Average Variable
Cost AVC
VC ÷ Q
20.0
19.5
19.7
21.0
24.0
26.7
30.3
33.8
37.8
42.0
Average Total Cost ATC
TC ÷ Q
120.0
69.5
53.0
46.0
44.0
43.3
44.6
46.3
48.9
52.0
Q0
1
2
3
4
5
6
7
8
9
10
Fixed Cost FC100
100
100
100
100
100
100
100
100
100
100
Variable Cost VC
20
39
59
84
120
160
212
270
340
420
Total Cost TC
FC + VC100
120
139
159
184
220
260
312
370
440
520
Average Fixed Cost AFC
FC ÷ Q
100
50
33
25
20
17
14
13
11
10
Average Variable
Cost AVC
VC ÷ Q
20.0
19.5
19.7
21.0
24.0
26.7
30.3
33.8
37.8
42.0
Average Total Cost ATC
TC ÷ Q
120.0
69.5
53.0
46.0
44.0
43.3
44.6
46.3
48.9
52.0
Marginal Cost MC
∆TC ÷ ∆Q
20
19
20
25
36
40
52
58
70
80
0306090
120150180210240270300330360390420450480510540570600
0 1 2 3 4 5 6 7 8 9 10
Total Cost Curve
Explicit Costs
Explicit Costs
Costs that require money
Implicit Costs
Implicit Costs
Costs that do not require money
Accounting Profit
Accounting Profit
Total Revenue minus explicit costs
Economic Profit
Economic Profit
Total Revenue minus both explicit costs and implicit costs
0
25
50
75
100
Accounting Profit Economic Profit
Accounting Profit = Total Revenue - Explicit Costs 100 - 30 = 70
Economic Profit = Total Revenue -
Explicit Costs - Implicit Cost 100 - 30 - 40 = 30
Efficient Scale
Efficient Scale
The quantity of output that
minimizes average total cost
Short Run vs.
Long Run
Short-Run
Short-Run
Cannot change a fixed cost
Long-Run
Long-Run
Can change all costs !
All costs become variable
Economies of Scale
Economies of Scale
Long-run average costs fall as quantity of output increases
Diseconomies of Scale
Diseconomies of Scale
Long-run average costs rise as quantity of output increases
Constant Returns to Scale
Constant Returns to Scale
Long-run average costs stays the same as quantity of output
increases
Qty
Break Even AnalysisSAR
Qty
Break Even AnalysisSAR
Fixed Cost - must pay regardless of quantity
Qty
Break Even AnalysisSAR
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Qty
Break Even AnalysisSAR
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Qty
Break Even AnalysisSAR
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Qty
Break Even AnalysisSAR
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Fixed Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Fixed Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Fixed Cost
Fixed Cost
plus Variable
Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Loss
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Loss
Profit
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Loss
Profit
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = FC + VC x Qty
Fixed Cost - must pay regardless of quantityVariable Cost - must
pay with each increase in quantity
Total Revenue = Price x Qty
Fixed Cost
Fixed Cost
plus Variable
Cost
Loss
Profit
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = Total Revenue
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = Total Revenue500 + 100 x Q = 200 x Q
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = Total Revenue500 + 100 x Q = 200 x Q
500 + 100Q = 200Q
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = Total Revenue500 + 100 x Q = 200 x Q
500 + 100Q = 200Q500 = 100Q
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = Total Revenue500 + 100 x Q = 200 x Q
500 + 100Q = 200Q500 = 100Q
5 = Q
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = Total Revenue500 + 100 x Q = 200 x Q
500 + 100Q = 200Q500 = 100Q
5 = Q
5
Qty
Break Even AnalysisSAR
500
Total Cost = 500 + 100 x Q
Total Revenue = 200 x Q
Total Cost = Total Revenue500 + 100 x Q = 200 x Q
500 + 100Q = 200Q500 = 100Q
5 = Q
5
1000