Chapter+13+The+Costs+of+Production

Chapter 13: The Costs of Production
 Chapter 13 explores the different COSTS and their relationships. Refer the Glossary for the **bold** terms.


Introduction - The //goal// of the firm is to maximize the **profit**. - **Total Cost = explicit costs + implicit costs** - //Example// to illustrate the difference between explicit costs and implicit costs - //Economists// consider both explicit and implicit costs whereas //accountants// usually consider explicit costs only. - **Accounting profit** is greater than **economic profit** because accounting profit does not include explicit cost.
 * Explicit cost: wage that firm pays (requires the actual money)
 * Implicit cost: the firm owner could use that wage in a different way if the owner didn't manage the firm

Diminishing Marginal Product Let's first look at the **Production Function**: As you can see, as the quantity of input increases, the quantity of output increases in small increments. Why is that? This is solely due to **Diminishing Marginal Product** (a.k.a. Diminishing Marginal Returns). At first, the quantity of output increases from an additional of input because the workers (inputs) have easy access to the equipments to produce the goods. However, as the number of workers increases, the factory becomes crowded and each additional worker makes it difficult to access the equipments. Therefore, as the input continues to increase, the output only increases slightly. For further explanation watch this (until about 2:03): media type="youtube" key="M7rA4VfvdAw" height="317" width="384" align="center"

Major Costs & Their Relationships -** Curves: **Marginal Cost (MC), Average Total Cost (ATC / AC), Average Variable Cost, Average Fixed Cost** - What does this graph tell us?
 * ANALYSIS
 * //Marginal Cost// decreases and then continues to increase. It declines at first because when the quantity of output is small, less input is used. So **marginal product** of an additional input is large while the marginal cost of an additional input is small. However, as the quantity of output increases, there is more input used so marginal cost increases.
 * //Average Fixed Cost// always declines because the **fixed cost** is spreading over a greater number of output (think about the formula for AFC).
 * //Average Variable Cost// increases as the quantity of output increases because of diminishing marginal product.
 * //Average Total Cost// is U-shaped. It is important to note that marginal cost intersects ATC at **efficient scale.** Moreover, when MC is less than ATC, ATC declines and when MC is greater than ATC, ATC rises. This occurs because if the cost of an additional unit is less than the current average cost, ATC will fall whereas if the cost of an additional unit is greater than the current average cost, ATC will rise.

Long Run (LR) & Short Run (SR) Average Total Cost (ATC) In SR, firms can only produce more by hiring more workers. However, in LR, firms can produce more by expanding the size of their factories or by building new ones. *Note: LR ATC is curved as well (corners are due to drawing). For the explanation of this graph, see below. media type="custom" key="5036275" - Why does the firm change its size? - Why is the LR ATC curve a flat U-shape? - How does the **economies of scale** arise? - How does the **diseconomies of scale** arise?
 * Short Run:** there is at least one fixed cost
 * Long Run:** NO fixed cost
 * Important to note the following:

Quiz ! 1. Why does the marginal cost decrease at first? 2. Where does the marginal cost intersect? 3. What is the difference between short run and long run? 4. How does the economies of scale occur? Answers

by Sally B.