CHAPTER+13

=**THE COSTS OF PRODUCTION** = media type="youtube" key="Q0HBteMWsTo" height="344" width="425" = = =WHAT ARE COSTS?=

Total Revenue, Total Cost, and Profit
- Economists assume that the goal of a firm is to maximize profit and make money
 * total revenue: ** the amount a firm receives for its sale of products
 * total cost: ** the cost of the inputs a firm uses for its production
 * profit: ** total revenue - total cost

Costs as Opportunity Costs
- An important difference between how economists and accountants analyze a business is the measure of these costs - Accountants disregard implicit cost since real cash exchange doesn't take place and only consider the explicit cost - Economists consider both costs since they consider the flow of money and not actual exchange
 * explicit cost: ** costs that a firm needs to pay to run the business
 * implicit cost: ** input costs that do not actually require any cost by firm

Economic Profit vs. Accounting Profit
- Economic profit is important because it motivates the firms that supply goods and services rather than physical exchange - Accounting profit is always larger than Economic Profit - When a firm makes economic losses (when economic profit is negative), the firms exit since they're not earning enough money to cover the cost of production
 * [[image:profit.gif width="291" height="270" align="left"]]economic profit: ** total revenue - total cost (cost include explicit and implicit)
 * accounting profit: ** total revenue - total explicit cost

= = = = = = = = =PRODUCTION AND COSTS=

The Production Function
- Remember that rational people think at the margin - As the number of workers (inputs) increases, the marginal product declines - the more workers are there, the more each additional worker will contribute less to the production of outputs - the slope of the production function measures the marginal product of a worker
 * production function: ** relationship between quantity of inputs and outputs
 * marginal product: ** the increase in output that occurs from each additional unit of input
 * diminishing marginal product: ** marginal product of an input declines as the quantity of input increases
 * - as the number of workers increases, the marginal product declines, and the production function becomes flatter **

From the Production Function to the Total-Cost Curve
- Number of input is related to quantity and the total cost of production - total-cost curve gets steeper as the product's quantity rise, whereas the production function becomes flatter - high production lead to diminishing marginal product

=VARIOUS MEASURES OF COST=

Fixed and Variable Costs
- fixed costs include rent - variable costs include cost of lemons, sugar, paper cups etc to sell leo exerze.
 * fixed costs: ** costs that do not depend on quantity or price of production
 * variable costs: ** costs that do depend on the quantity of output produced

Average and Marginal Cost
- although ATC tells us the cost, it doesn't indicate potential change in the level of production - ATC illustrates the unit of output if total cost is divided evenly. - Margianl cost illustrates the increase in total cost due to producing an additional additional unit of output
 * average total cost: ** total cost / quantity
 * average fixed costs: ** fixed costs / quantity
 * <span style="color: rgb(4, 143, 33);">average variable costs: ** variable costs / quantity
 * <span style="color: rgb(4, 143, 33);">marginal costs: ** increase in total cost due to extra unit of production
 * <span style="color: rgb(4, 143, 33);">: ** Δ total cost / Δ quantity

Cost Curves and Their Shapes
- The graph shows three main curves: AVERAGE TOTAL COST (ATC), AVERAGE VARIABLE COST (AVC), AND MARGINAL COST (MC) **AVERAGE FIXED COST (not shown on graph)** **- As you can see, marginal cost is directly related to quantity, meaning that the higher the marginal cost, the more the output - the marginal product of an extra worker is large, and marginal cost becomes small - producing more by hiring more workers is one thing, yet letting the workers work in a crowded condition is another factor to consider - when the quantity of a good rises, the marginal product of an extra worker is low, and marginal cost of an extra unit is large
 * <span style="color: rgb(33, 54, 222);">RISING MARGINAL COST

** - because the average total cost is the sum of average FC and average VC, the curve reflects upon the basic theory - ATC declines as output rises (FC) and then curves back up in U-shape and rises again as quantity continues to rise
 * <span style="color: rgb(33, 54, 222);"> U-SHAPED AVERAGE TOTAL COST

<span style="color: rgb(33, 54, 222);"> **THE RELATIONSHIP BETWEEN MARGINAL COST AND AVERAGE TOTAL COST** - MC < TC, ATC falls - MC > TC, ATC rises - MC crosses the ATC curve at its minimum, which is the most important aspect of competitive firms - it's also the most EFFICIENT point in terms of production

**Typical Cost Curves**
- MC rises eventually rises with the quantity of output due to diminishing marginal cost - ATC is U-Shaped - ATC and MC crosses at ATC's minimum point

=**COSTS IN THE SHORT RUN AND IN THE LONG RUN**=

**The Relationship between Short-run and Long-run Average Total Cost**
- TC between FC and VC depends on time - many decisions are fixed in short term, but variable in long tern, thus the two curves depending on time differ - long term curve is flatter and stable compared to varying short term curves - as a result, in long term, the firm gets to choose which short run curve it wants to be and set goals starting from there - this cannot be done in short term because the firm cannot change so dramatically and expect expectations beyond limits

**Economies and Diseconomies of Scale**
<span style="color: rgb(255, 255, 255);">here output increases as well as ATC <span style="color: rgb(4, 143, 33);"> case wher <span style="color: rgb(255, 255, 255);">here output increases as well as ATC <span style="color: rgb(4, 143, 33);"> case wher <span style="color: rgb(255, 255, 255);">er
 * <span style="color: rgb(4, 143, 33);">economies of scale: ** a case where output increases and ATC decreases
 * <span style="color: rgb(4, 143, 33);">diseconomies of scale: ** a case where output increases as well as ATC
 * <span style="color: rgb(4, 143, 33);">constant returns to scale: ** a case where ATC is independent of output

QUESTIONS
1. What's the difference between economic profit and accounting profit? <span style="color: rgb(153, 21, 45);">The difference between economic profit and accounting profit is the matter of inclusion of implicit cost. Economists do consider both explicit cost and implicit cost in calculating total revenue, whereas accountants only consider the explicit cost. Economists care about any sort of financial movement that does as well as could have made a difference on a firm's overall profit. Since accountants think that tangible money (cost) is more important, it only subtracts the explicit cost from total revenue unlike the economists. Thus, economic profit is smaller than accounting profit. 2. List the important types of cost <span style="color: rgb(153, 21, 45);">**EXPLICIT COSTS:** costs that require spending by the firm CITATION http://www.pmcl.com/nedprototype/Images/profit.gif http://ingrimayne.com/econ/LogicOfChoice/Figure7.4.gif http://classnotes.aaec.vt.edu/aaec1005/coursematerials/SupplyExamples/costs3.jpg\ http://economicobjectorvism.files.wordpress.com/2007/07/lratc.jpg
 * IMPLICIT COSTS:** costs that do not require actual spending by the fim
 * FIXED COSTS:** costs that do not vary; independent of quantity
 * VARIABLE COSTS:** costs that do vary depending on quantity
 * TOTAL COST:** FC + VC
 * AFC:** FC / Q
 * AVC:** VC / Q
 * ATC:** TC / Q
 * MARGINAL COST:** change of TC / change of Q