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Chapter 8Chapter 8Chapter 8Chapter 8Costs of Production Costs of Production Principles of Economics

by Fred M GottheilPowerPoint Slides prepared by Ken Long

©©1999 South-Western College Publishing

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What is a Production Function?

What is a Production Function?

A relationship between inputs and

outputs

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Q = f(L, C)Q = f(L, C)

• Q = output• L = labor input• C = capital input

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What is the Short Run?What is the Short Run?A time in which producers

can change some, but not all of its resources (inputs)

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What is the Long Run?What is the Long Run?The time period in which

producers can change any of its resources

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Example of a production functionTP = total product or output, MP

= marginal product

Example of a production functionTP = total product or output, MP

= marginal product

Labor TP MP0 01 10 102 24 143 36 124 46 105 52 66 54 27 54 08 52 -2

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Total and marginal product curvesTotal and marginal product curves

Total Product

Labor

Marginal Product

Labor

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Marginal Product

LaborI II

III

•Zone 1, increasing MP

•Zone 3, negative MP

•Zone 2, diminishing MP

•Can you see why the firm is likely to end up operating in zone 2?

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What is the Law of Diminishing Returns?What is the Law of

Diminishing Returns?As more units of a

resource are added to production output will increase by smaller amounts, ceteris paribus

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Short Run Costs of Production

Short Run Costs of Production

Total costs = Total Fixed costs + Total Variable costs

TC = TFC + TVC

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What is a Fixed Cost?What is a Fixed Cost?Cost to a firm that does

not vary with the quantity of goods produced

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What are examples of Fixed Costs?

What are examples of Fixed Costs?

• rent or mortgage• loan payments• certain salaries• a part of utilities• property taxes

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What are some other names for Fixed Cost?What are some other

names for Fixed Cost?

Sunk and Historical

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What is a Variable Cost?What is a Variable Cost?Cost that varies with the

quantity of goods produced

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What are examples of Variable Costs?

What are examples of Variable Costs?• worker’s wages• raw materials• some utilities• some taxes

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What isTotal Variable Cost?

What isTotal Variable Cost?The sum of specific

variable costs in the firm’s cost structure

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Total Fixed cost curveTotal Fixed cost curve

Q

TFC

0

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Total Variable Cost CurveTotal Variable Cost Curve

Q

TVC

0

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Total Costs, Sum of Variable and Fixed Cost

Total Costs, Sum of Variable and Fixed Cost

Q

TC

0

TVC

TFC

TC

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What isAverage Total Cost?

What isAverage Total Cost?

Total cost divided by the quantity of goods produced

ATC = TC/Q

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What isAverage Fixed Cost?

What isAverage Fixed Cost?Total fixed cost divided by

the quantity of goods produced

AFC = TFC/Q

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What isAverage Variable Cost?

What isAverage Variable Cost?

Total variable cost divided by the quantity of goods produced

AVC = TVC/Q

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ATC

AVC

Ave. Fixed Costs

23Q

$

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What isMarginal Cost?

What isMarginal Cost?

The change in total cost generated by a change in the quantity of a good produced

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MC = Q

TC =

TVCQ

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Why does MC = ATC at minimum ATC?

Why does MC = ATC at minimum ATC?

If the margin is above the average, the average increases

If the margin is below the average, the average decrease

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$

Q

ATC

AVC

MC

Ave. Fixed Costs

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What areEconomies of Scale?

What areEconomies of Scale?

When a firm increases resources in the long run and efficiency increases

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What can cause economies of scale?

What can cause economies of scale?

• Increased specialization• Specialized capital

equipment• Dimensional factors

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What areDiseconomies of Scale?

What areDiseconomies of Scale?

When a company increases resources in the long run and efficiency decreases

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What can cause diseconomies of scale?

What can cause diseconomies of scale?

• Limits to efficient functioning of management

• Layers of bureacracy

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Costs in the Long Run and Economies of Scale

Costs in the Long Run and Economies of Scale

Output

Cos

t p

er u

nit

AC

Economiesof scale

Diseconomiesof scale

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The Family of Short-Run Average Cost Curves

The Family of Short-Run Average Cost Curves

Output per period

$Long-run

average costATC1

ATC2

ATC3

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What are different views concerning downsizing?What are different views concerning downsizing?

http://www.visioncoach.com

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What isLabor Productivity?

What isLabor Productivity?

The output per laborer per hour

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Which is cheaper to pay $10 an hr. to a U.S.

worker or $1 an hour to a foreign worker?

Which is cheaper to pay $10 an hr. to a U.S.

worker or $1 an hour to a foreign worker?

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The $10 an hour may be cheaper if the U.S. worker is a lot more productive than the foreign worker

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• What is a Fixed Cost?• What is a Variable Cost?• What are Total Costs?• What is Marginal Cost?• What is the Short Run?• What is the Long Run?• What are Economies of Scale?• What are Diseconomies of Scale?

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