The Cost of Production

Industrial organization- depending on the market condition, firm’s decisions about price and quantities vary.

COST

Total Revenue, Total Cost, and Profit
Total revenue: total amount of money received by firm from the sale of a product
Total cost: economic cost of production. They are made up of variable costs and fixed cost
Profit: maximum amount of money that all firms wish to make. Total revenue – Total cost
You opened U-Dong restaurant. The amount of money received by selling U-Dong is total revenue. The amount of money that is used to buy inputs (noodle, soup, onions, etc.) is called total cost. The amount of money left after use of total cost is profit.
Profit= Total revenue – Total cost

Cost as Opportunity Cost
Opportunity Cost: refer to chapter 1
Explicit Cost: financial credit (wage, rent, or material). Money paid and lost directly
Implicit Cost: opposite of explicit cost. Amount of money counted as opportunity cost.
These two ideas differentiate between how economists and accountants study their businesses. While economists examine how firms decide pricing and production, accountants track money that goes in and out of firms.

Economic Profit vs. Accounting Profit
Economic profit: total revenue – total cost (Includes explicit and implicit costs -> opportunity cost).
Accounting profit: total revenue – total explicit cost
Accountants has larger compared to economists because accountants ignore implicit cost.

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PRODUCTION AND COSTS

Production function vs. total cost curve IMG_0349.JPG
Production function: relationship between the workers and the amount of production they create.
Marginal product: increase of how much quantity of productions produced per one unit of that production.
Diminishing marginal product: the increase of output as the input increases. At this time, the input is constant.


(left: Product Function Graph, right: Total-cost curve)
The production function is the relationship between the workers and the amount of production they create. The graph of production function becomes flatter because the numbers of workers increase every year. This refers to diminishing marginal product. The Total cost curve represents the relationship between the quantity of productions produced and total cost production. The curve gets steeper because quantity productions produced increases. This refers to diminishing marginal product as well.


Fixed and Variable Costs
Fixed cost: cost where the quantity of output produced is not included
Variable cost: cost where the quantity of output produced is included
Fixed costs are like a bookshelf in library where the output is essentially needed. Variable costs are the books. In short run, when firms shut down, variable cost may move out but fixed cost stay as it is because firm can enter anytime.
Total cost= fixed cost + variable cost


Average and Marginal Cost, Cost Curves and Shape of curves
Average total cost: average of total cost. Total cost / Quantity
-U shaped
-Total cost = fixed + variable cost, therefore, ATC is (fixed cost + variable cost) / Quantity. Fixd cost always decline when output increase. On the bottom of U shaped ATC, there is efficient scale, which is the minimum quantity of average total cost.
Average Fixed Cost: Fixed Cost / Quantity
Average Variable Cost: Variable cost / Quantity
Marginal Cost: the amount of total cost increase per one unit of output increase
-When MC is lower than ATC, ATC decreases
-When MC is higher than ATC, ATC increases
-The MC curve crosses ATC at the minimun point because ATC can only start to increase when MC crosses the minimum
all_costs.gif


Short Run and Long Run ATC
-decisions can be fixed in short run

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-in long run, since the fixed cost is the variable, the short run ATCs are different from long run ATCs
-in long run, ATC is more flatter U-shape
-in short run, ATC is more U-shape

Economies and Diseconomies of Scale
-economies of scale: when ATC in long run decrease as output increase, there is economies of scale
-the exact opposite side, where ATC in long run increase as output increase, there is diseconomies of scale
-the horizontal section of long run, where there is no change of output, there is constant returns to scale





Summary
Industrial organization- depending on the market condition, firm’s decisions about price and quantities vary. There is always an opportunity cost for doing something in the market. Even though one firm raises revenue, they have to subtract the amount of cost used. There are implicit and explicit costs, accounting and economic profit. Variable cost and fixed cost are also a part of one’s cost. The market decisions differ depending on whether it’s a short run or long run.









Questions:
1. _ is the condition of output where it brings ATC to minimum value
2. What are some of the eqations for Average Total Cost?
3. ATC in most graphs are usually _-shaped
4. The Total cost curve represents the relationship between the workers and the amount of production they create. (T/F)
5. Give an example of fixed cost and variable cost in real life

Answers:
1. efficient scale
2. ATC= TC / Q or (FC+VC)/Q
3. U
4. F, The Total cost curve represents the relationship between the quantity of productions produced and total cost production
5. fixed cost: quantity of lemonade produced in lemonade cafe
variable cost: outputs to make lemonade: sugae, lemon, cups, straws, etc.

picture source: http://www.bized.co.uk/glossary/big/all_costs.gif
Mankiw Principles of Microeconomics Fourth Edition chapter 13.