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ECON 101

Chapter 13 The Cost of Production

Examples of a town of Lots of pizza shop but have one cable TV
What are the Costs?
Buying material to make a product, including the machinery,
place and cost of selling material
Total Revenue, Total Cost and Profit:
Total Revenue: Amount received after the exchange for the sale
of firms product
Total Cost: Market value of the effort a firm puts in production
Profit: TR TC
Opportunity Costs
Cost given up in order to gain something and forgone
Firms cost of production includes all opportunity costs of making
its output of goods and services
Explicit Costs: Input costs that require an outlay of money by
the firm
Implicit Costs: Input costs that dont require an outlay of
money by firm
The Cost of Capital as an Opportunity Cost
The Implicit cost of business is the opportunity cost of
Financial Capital invested in business
o Example
Using personal saving to buy a factory
But the money from personal saving earns interest
left in the bank
The forgone interest = implicit opportunity cost of
Financial capital
Economic Profit VS Accounting Profit
Economist Measure: Firms Total Revenue All the Opportunity
Cost of producing good and services sold
Accounting Profit: Firms Total Revenue Only Explicit Costs

Production and Costs

Production Functions
o The relationship between the quantity of input used to
make the goods and quantity of output of goods

Marginal Product: increase in output that arise from additional

unit of input
Diminishing Marginal Product: property where the marginal
product of an input declines as the quantity of the input

The Various Measure of Cost from Firms Total Cost

Fixed Cost: Cost that do not vary with quantity of output
Variable Cost: Cost that do vary with the Quantity of output

Total Cost = Fixed cost +Variable Cost

Average and Marginal costs

Average Total Costs (ATC) = Total Cost / Quantity of Output
Average Fixed Costs (AFC) = Fixed Costs / Quantity of Output
Average Variable Costs (AVC) = Variable Costs/ Quantity of
Marginal Cost (MC) = Increase in total cost came when extra unit
was produced
o ATC = TC/ Q
o MC= Difference TC/ Difference Quantity
Cost Curves and Their Shapes
Rising Marginal Cost
o Marginal Cost rise with quantity of output produced
resulting in diminishing marginal product
U Shaped Average Total Cost
o Average total cost is the sum of fixed costs and average
variable cost
o Average Fixed cost always declines as output rise
Fixed cost is expanded over large number of units
o Average Variable Cost always rises
Output increases because of diminishing marginal
Efficient Scale: Quantity of output which minimize average total
Relationship between Marginal Cost and Average total cost
When Marginal cost is less than average total cost = fall of
Average total cost

When Marginal cost if high than average total cost= Rise in

Average total cost

Typical Cost Curves

Have three properties which are very important
1. Marginal cost eventually rise with quantity of output
2. Average total cost curve is U shaped
3. Marginal cost curve crosses average total cost and
minimum of average total cost
Costs in the SHORT RUN and In the LONG RUN and their relationship

Division of total cost between fixed and variable depends on the

time horizon
Fixed cost decisions are short run and variable cost are long run

Economies and Diseconomies of Scale

Economies of scale
o Long run average total cost falls as the quantity output
Diseconomies of Scale
o Long run average total cost rise as the quantity output
Constant Return to Scale
o Long run average total cost stays same as the quantity of
output changes