EC120 Chapter 13-The Costs of Production Week 6
What are Costs?
Total Revenue, Total Cost, and Profit
-Helen started her cookie business to make money.
-Economists normally assume that the goal of a firm is to maximize 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 - total revenue minus total cost
-Profit=Total revenue – Total cost
Costs as Opportunity Costs
-When economists speak of a firm’s cost of production, they include all the opportunity costs of making
its output of goods and services
-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 by the firm
The Cost of Capital as an Opportunity Cost
-An important implicit cost of almost every business is the opportunity cost of the financial capital that
has been invested in the business
-If Helen has instead left the $300 000 she used to purchase the company in a savings account it would
have earned $15 000 interest. This is an implicit cost to an economist.
Economic Profit versus Accounting Profit
-Economic Profit-total revenue minus total cost, including both explicit and implicit costs
-Accounting Profit-total revenue minus total explicit cost
-Economic profit is an important concept because it is what motivates the firms that supply goods and
Production and Costs
-We assume that the size of Helen’s factory is fixed and that Helen can vary the quantity of cookies
produced only by changing the number of workers
The Production Function
-Production Function-the relationship between quantity of inputs used to make a good and the quantity
of output of that good EC120 Chapter 13-The Costs of Production Week 6
-We are dealing with a short-run production function, which allows the number of workers to vary but
holds the size of Helen’s factory as fixed
-Marginal Product – the increase in output that arises from an addition unit of input
-As the number of workers increases, the marginal product declines.
-This property is called the diminishing marginal product – the property whereby the marginal product
of an input declines as the quantity of the input increases
-At first, when only a few workers are hired, they have easy access to Helen’s kitchen equipment. As the
number of workers increases, additional workers have to share equipment and work in more crowded
conditions. Hence, as more and more workers are hired, each additional worker contributes les to the
production of cookies
From the Production Function to the Total-Cost Curve EC120 Chapter 13-The Costs of Production Week 6
The Various Measures of Cost
Fixed and Variable Costs
-Fixed costs-costs that do not vary with the quantity of output produced. Incurred even if the firm
produces nothing at all.
-Variable costs-costs that do vary with the quantity of output produced. The more lemonade that
Thelma makes, the more items she needs to buy
-A firm’s total cost is the sum of fixed and variable costs
Average and Marginal Costs
-As the owner, Thelma must decide how much to produce. She may ask her production supervisor the
How much does it cost to make the typical glass of lemonade?
How much does it cost to increase production of lemonade by one glass?
-These questions do not have the same answ