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ECON 1B03 (303)
Chapter 13

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Krishnakali Sen Gupta

Chapter 13: The Cost of Production The firm’s goal is to maximize profit: Profit = total revenue-total cost P=TR-TC  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.  Ten Principles: 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 decisions. 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 of output.  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. Marginal Product:  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.  Notation: ∆ (delta) = “change in…” Examples: ∆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 fixed) Marginal Cost:  Marginal Cost (MC): the increase in Total Cost from producing one more unit of output: MC= / Average total cost (ATC) equals total cost divided by the quantity o
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