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=The Costs of Production =

__**BASIC TERMS**__

Total Cost = Variable Cost + Fixed Cost Fixed Cost = the cost that is fixed and does not change no matter what the input and the output is Variable Cost = the cost that is directly proportional and thus changes due to the change of output

Average Total Cost = Average Variable Cost + Average Fixed Cost Explicit Cost = the cost required to produce the product Implicit Cost = the opportunity cost

Economic Profit = Total Revenue - explicit cost - implicit cost Accounting Profit = Total Revenu - explicit cost

Usually, accounting profit is greater than the economic profit.

Marginal Product =∆Total Product / ∆ Input

Marginal 'something' 's graph is the graph of the derivative function of 'something' Average 'something' 's graph is the graph that shows the slope of the line that shows up when connecting points of the graph to the origin.

Total Revenue: the amount a firm receives for the sale of its output Profit: total revenue minus total cost Economic Profit: total revenue minus total cost, including both explicit and implicit cost. Accounting profit: total revenue minus total explicit cost

Production function: the relationship between quantity of inputs used to make a good and the quantity of output of that good Marginal Product: the increase in output that arises from an additional unit of input Diminishing marginal product: the property whereby teh marginal product of an input declines as the quantity of the input increases

Efficient Scale: the quantity of output that minimizes average total cost Economies of scale: the property whereby long-run average total cost falls as the quantity of output increases Diseconomies of scale: the property whereby long-run average total cost rises as the quantity of output increases. Constant returns to scale: the property whereby long-run average total cost stays the same as the quantity of output changes

Production Function
The graph of the production function looks like the following:

As one can see, the output increase more and more dramatically as the quantity of input increases in the beginning. However as time passes, the output increases in a smaller amount, then reaches the maximum point, then starts to decrease. This is called the "Law of Diminishing Product".

The output in the beginning increases in a greater amount because it is the area of increasing marginal product. For example, if a person who was in a desert for 3 days drinks a bottle of water (consider this as the quantity of input), the first sip will feel awesome. The first bottle will be so good. As the person drinks more, the happiness (consider this as the output) he feels will decrease. And later if he is full, drinking more water will decrease his happiness. This is why there is also the area of diminishing marginal product, where the output starts to increase in a smaller amount, then starts to decrease.

Average Cost

 * Average Cost is simply the total cost divided by the quantity produced. If we look in the graph, we can find the average cost be looking at the slope between two points (the point of input and the origin).

Marginal Cost

 * Marginal Cost is the change of total cost (∆cost) divided by the change of quantity produced (∆product). If we look in the graph, we can find the marginal cost by getting the instantaneous slope of the graph at a certain point.



Using these methods to get the marginal cost graph and average cost graph (including average total cost, average variable cost, and average fixed cost), if we combine three graphs of marginal cost, average total cost, and average variable cost, the graph looks like the following:

There are some important points.

The marginal cost graph passes through the lowest point of the average total cost graph and the average variable cost graph. The reason for this is that the lowest point of the average total cost and the average variable cost is when the line that connects the two point is tangent to the graph. This also means that the line is showing the marginal cost. Therefore when the marginal cost equals to one of the cost graphs (average total or average variable cost), it means the cost graphs are at their minimum point.

Also it is important to understand that when average total cost and average variable costs are decreasing, they are greater than the marginal cost. However, when the average total cost and the average variable cost graph passes its lowest point and starts to increase, marginal cost is greater than those two graphs.