Chapter 13: The Cost of Production
The firm’s goal is to maximize profit: Profit = total revenue-total cost
Explicit costs require an outlay of money,
e.g., paying wages to workers.
Implicit costs do not require a cash outlay,
e.g., the opportunity cost of the owner’s time.
The opportunity cost of something is
what you give up to get it.
This is true whether the costs are implicit or explicit. Both matter for firms’ output and pricing
Economic Profit: Total Revenue – (Total Cost + Implicit (renting, selling, lending or forgone costs of not
choosing to work) and explicit costs (wage, rent, materials)
Accounting profit: Total Revenue – Total Cost A Production Function:
A production function shows the relationship between the quantity of inputs and the quantity
It can be represented by a table, equation, or graph.
Example 1: Farmer Jack grows wheat.
• He has 5 acres of land (FOP).
• He can hire as many workers (FOP) as he wants.
If Jack hires one more worker, his output rises by the marginal product of labour.
The marginal product of any input is the increase in output arising from an additional unit of
that input, holding all other inputs constant.
∆ (delta) = “change in…”
∆Q = change in output, ∆L = change in labour
Marginal product of labour (MPL) = ∆Q / ∆L
Why MPL Is Important? Recall one of the Ten Principles:
Rational people think at the margin.
When Farmer Jack hires an extra worker,
• his costs rise by the wage he pays the worker (marginal cost)
• his output rises by MPL (marginal benefit)
Comparing marginal cost with marginal benefit helps Jack decide whether he would benefit
from hiring the additional worker.
Why MPL Diminishes?
Farmer Jack’s output rises by a smaller and smaller amount for each additional worker. Why?
As Jack adds workers, the average worker has less land (assumed fixed) to work with
and will be less productive.
In general, MPL diminishes as L rises
whether the fixed input is land or capital (equipment, machines, etc.).
Diminishing marginal product:
the marginal product of an input declines as the quantity of the input increases (other inputs
Marginal Cost (MC):
the increase in Total Cost from
producing one more unit of output:
Average total cost (ATC) equals total cost divided by the quantity o