Chapter 13 The Costs of Production.docx
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Chapter 13 The Costs of Production
Total Revenue, Total Cost and Profit
Total Revenue (For a Firm): The amount a firm receives for the sale of its output.
Total Cost: The market value of the inputs a firm uses in production.
Profit: The revenue minus the total cost.
The assumption is that firms produce and sell goods to maximize profit
Costs as Opportunity Costs
Explicit Costs: Input costs that require an outlay of money by the firm.
Implicit Costs: Input costs that do not require an outlay of money for the firm.
We must think about the opportunity costs, the next best alternative must be included as a
part of the costs of the firm.
The Cost of Capital as an Opportunity Cost
We must also think about the financial capital of the money that was invested in the firm.
The next best alternative of say 5% interest on that same money in the bank then that
must be added to the costs.
Economic Profit: Total Revenue minus total cost, including both explicit and implicit
Accounting Profit: Total Revenue minus total explicit cost.
A firm making positive economic profit will stay in business. If the economic profit is
less then the economic profit, then the firm is failing to cover the costs of the business
and unless things change, then the firm will eventually close down and exit the industry.
Production Function: The relationship between inputs and outputs. It tells you the
amount of inputs needed to get any given amount of outputs.
The slope of the production function is called the Marginal Product of Labour.
This represents 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.
Production Function to the Total-Cost Curve
The more people you hire the higher the total costs increase. This graphically, has a
steeper slope per unit of output. This is because the marginal cost is getting higher, as
represented by the slope. Because there is eventually a maximum output no matter how
many more people you hire you will not increase output and the costs will go up while
quantity produced does not increase.
The Various Measures of Cost
Fixed Cots: Costs that do not vary with the quantity of output produced.
Things like rent (Assuming you don’t rent more space at a certain point).
Variable Costs: Costs that do vary with the quantity of output produced.
Things like wages, the more workers you have the more output and more you pay.
A firm’s total cost includes the fixed and variable costs.
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