ECN 104 Lecture Notes - Average Variable Cost, Average Cost, Marginal Cost
2 Jul 2018
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Chapter 13 - The Costs of Production
●Industrial organization → the study of how firms’ decisions regarding prices and
quantities depend on the market conditions they face.
→ Ex. how the number of firms in an area affect prices and market efficiency.
● A firm's costs are a key determinant of its production and pricing decisions.
What are Costs?
Total Revenue, Total Cost, and Profit
● Firm’s objective → to maximize profits.
●Total revenue → the amount a firm receives for the sale of its output (Qs x price).
●Total costs → the amount a firm pays to buy inputs for production.
●Profit = total revenue - total costs
Costs as Opportunity Costs
● Principle #1 Opportunity cost → must give something up to get something
●Explicit costs → input costs that require a payment of money from the firm.
●Implicit costs → input costs that do not require a money payment (opportunity costs).
● Economists → interested in firms production and pricing decisions - care for both costs.
● Accountants → only care for explicit costs (transactions and flow of cash).
→ ignore implicit costs, therefore profit is higher than economic profit.
The Cost as Capital as an Opportunity Cost
Example: You need $100,000 to start your business. The interest rate is 5%.
Case 1: borrow $100,000
●Explicit cost → $5,000 interest on the loan
Case 2: use $40,000 of your own money, borrow $60,000
●Explicit cost → $3,000 (5%) interest on the loan
●Implicit cost → $2,000 (5%) foregone interest you could have earned if you didn’t spend
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the $40,000 of your own money.
In both cases, total costs (explicit + implicit) = $5,000
Economic Profit Vs Accounting Profit
●Economic profit
→ total revenue - all the opportunity costs (explicit + implicit) of producing the goods.
→ what motivates a business.
●Accounting profit
→ total revenue - explicit costs
→ typically larger than economic profit.
Production and Costs
● Assumption → quantity of goods produced only changes by number of workers.
The Production Function
●The product function → the relationship of the quantity of inputs (workers) used to
make a good and the quantity of output of that good.
● Rational people think at the margin → key in decision making for how many workers to
hire and how many outputs to produce.
●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.
→ the more workers, the more they have to share the equipment.
From The Production Function to The Total-Cost Curve
● Total cost curve → shows relationship between quantity produced and total costs.
● More workers = more costs.
● Slope gets steeper when quantity produced is large.
The Various Measures of Cost
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Document Summary
Industrial organization the study of how firms" decisions regarding prices and quantities depend on the market conditions they face. Ex. how the number of firms in an area affect prices and market efficiency. A firm"s costs are a key determinant of its production and pricing decisions. Total revenue the amount a firm receives for the sale of its output (qs x price). Total costs the amount a firm pays to buy inputs for production. Profit = total revenue - total costs. Principle #1 opportunity cost must give something up to get something. Explicit costs input costs that require a payment of money from the firm. Implicit costs input costs that do not require a money payment (opportunity costs). Economists interested in firms production and pricing decisions - care for both costs. Accountants only care for explicit costs (transactions and flow of cash). Ignore implicit costs, therefore profit is higher than economic profit. The cost as capital as an opportunity cost.
