COST of PRODUCTION

Price of a good which is determined by the sum of the costs of the resources that went

into making itCOST

REVENUE

PROFIT

OPPORTUNITY COSTThe value of most appealing

alternative that is not chosen is called opportunity cost

1. To work all day and make some money

2. To take the day off and go to a movie

Opportunities

Opportunity cost = Explicit cost + Implicit cost

Explicit CostInput cost that requires an

outlay of money

Implicit CostInput cost that DO NOT

requires an outlay of money

To open a computer software firm. Payments that must be made include

• computer hardware, • utilities, • supplies, • property and other taxes,• maintenance costs, • payments to wholesalers,• salaries of office support staff

EXAMPLE of EXPLICIT COST

If starts computer software firm in his own building

• Owner works 60 hours a week• Lease payment or rent he would

otherwise receive • Could earn if invested elsewhere• Salaries they could earn if employed

in another business

EXAMPLE of IMPLICIT COST

Various Costs & their Measurements

QuantityFixed cost

Variable cost

Total cost=F.C+V.C

Average fixed cost=FC/Q

Average variable cost=VC/Q

Average total cost=AFC+AVC

Marginal costChange in total cost/change in quantity

0 $3 $0.0 $3 --- --- ---

$0.31 3 0.3 3.3 $3.0 $0.30 $3.3

0.52 3 0.8 3.8 1.5 0.40 1.9

Fixed Cost Costs that do not vary with the quantity of output produced e.g. salaries or rents

Variable Cost Costs that do vary with the quantity of output produced e.g. raw materials and additional labors

Marginal Cost The increase in total cost that arises from an additional unit of production.

Average Cost How much does it cost to make a typical unit of production.

Explicit Cost + Implicit Cost

Only Explicit Cost

Economic profit is always less than the accounting profit

No. of workers/ quantity

Output quantity of cookies produced/hour

Marginal product

Fixed cost/ cost of factory

Variable cost/ cost of workers

Total cost of inputs= F.C+V.C

0 0$50

$30 $0 $30

1 5040

30 10 40

2 9030

30 20 50

3 12020

30 30 60

4 14010

30 40 70

5 1505

30 50 80

6 155   30 60 90

Production Function

The relationship between quantity of input and output

Maximum output that can be produced from any combination of inputs available in a given time period

Law of Diminishing Marginal ProductThe property where the marginal product of an

input declines as the quantity of the input increases

Comparison of TC and Production Function

Shapes of Cost Curves & their Relationships

• MC first decline then will go up, intersects AVC & ATC• AVC go down, but not as steeply as MC, then go up• AFC declines continuously• ATC initially declines as FC is spread over a larger number of units,

but will go up as marginal costs increase due to the law of diminishing returns