Costs: Explicit vs.

Implicit
Explicit costs require an outlay of
money,
e.g. paying wages to workers
Accounting profit
= total revenue minus total explicit
costs
Implicit costs (Opportunity Costs)
do not require
Economic profit a cash outlay
e.g. the revenue
= total cost of the owners
minus totaltime
costs
(including explicit and implicit
costs)
Costs

Fixed Costs:
costs of production that we cannot
change
Variable Costs:
costs of production that we can
change
Total Cost
Addition of Fixed cost and Variable
cost
 Deriving Costs
curves $800 FC
Q FC VC TC $700 VC
$10 TC
0 $100 $0 $600
0
1 100 70 170 $500

Costs
2 100 120 220
$400
3 100 160 260
$300
4 100 210 310
$200
5 100 280 380
$100
6 100 380 480
$0
7 100 520 620 0 1 2 3 4 5 6 7
Example:
FC = Cost of land Q
VC = Wages to labor
 Average Fixed Cost:
Total Fixed Cost/Output, the average
fixed cost per unit of production
Average Fixed Cost curve
Q FC AFC Average fixed cost (AFC)
$10
0 n.a.
0 is fixed cost divided by the
1 100 $100 quantity of output:
2 100 50 AFC = FC/Q
33.3
3 100
3
4 100 25
5 100 20
16.6
6 100
7
14.2
7 100
9
 Average Variable Cost:
Total Variable Cost/Output, the average
variable cost per unit of production
Average Variable Cost curve
Q VC AVC Average variable cost
(AVC)
0 $0 n.a.
is variable cost divided by
1 70 $70 the quantity of output:
2 120 60 AVC = VC/Q
3 160 53.33 As Q rises, AVC may fall
4 210 52.50 initially. In most cases, AVC
will eventually rise as output
5 280 56.00
rises.
6 380 63.33
7 520 74.29
Average Total Cost Curves

Q TC ATC $200
$10 Usually, the ATC curve is
0 n.a. $175
0 U-shaped.
1 170 $170 $150

2 220 110 $125

Costs
86.6 $100
3 260
7
77.5 $75
4 310
0 $50
5 380 76
$25
6 480 80
$0
88.5
7 620 0 1 2 3 4 5 6 7
7
Q
Average Cost curve

Q TC ATC AFC AVC Average total

$10 cost (ATC) equals
0 n.a. n.a. n.a.
0 total cost divided
1 170 $170 $100 $70 by the quantity of
2 220 110 50 60 output:
86.6 33.3 ATC = TC/Q
3 260 53.33
7 3 Also,
77.5
4 310 25 52.50
0 ATC = AFC + AVC
5 380 76 20 56.00
16.6
6 480 80 63.33
7
88.5 14.2
7 620 74.29
7 9
 Cost Concepts
Marginal Cost
the addition to cost associated
with one additional unit of output
Marginal Cost = Change in Total Cost
Change in Output
= TC
q
Marginal Cost curve

Q TC MC Marginal Cost (MC)

$10 is the change in total cost
0
0 $70 from producing one more
1 170 unit:
50 TC
2 220 MC =
Q
40
3 260 Usually, MC rises as Q rises,
50 due to diminishing marginal
4 310
70 product.
5 380
100 Sometimes, MC falls before
6 480 rising.
140
7 620 (In rare cases, MC may be
constant.)
The Various Cost Curves Together

$200

$175
$150
ATC
$125

Costs
AVC
$100
AFC
MC $75
$50

$25
$0
0 1 2 3 4 5 6 7
Q
Why ATC Is Usually U-shaped
As Q rises: $200

Initially, $175
falling AFC $150
pulls ATC $125

Costs
down.
$100
Eventually,
$75
rising AVC
$50
pulls ATC up.
$25
$0
0 1 2 3 4 5 6 7
Q
Important Economic Relation: ATC
and MC
When MC < ATC, $200 ATC
ATC is falling. MC
$175
When MC > ATC, $150
ATC is rising. $125

Costs
The MC curve $100
crosses the $75
ATC curve at
$50
the ATC curves
$25
minimum.
$0
0 1 2 3 4 5 6 7
Q
Costs in the Short Run & Long Run

Short run:
Some inputs are fixed (e.g., factories,
land).
The costs of these inputs are FC.
Long run:
All inputs are variable
(e.g., firms can build more factories,
or sell existing ones)
LRATC with 3 Factory Sizes
Firm can choose Avg
from 3 factory Total
sizes: S, M, L. Cost ATCS ATCM
Each size has its ATCL
own SRATC
curve.
The firm can
change to a
different factory Q
size in the long
run, but not in
the short run.
EXAMPLE 3: LRATC with 3 Factory Sizes
To produce less
than QA, firm will Avg
Total
choose size S
Cost ATCS ATCM
in the long run. ATCL
To produce
between QA
LRATC
and QB, firm will
choose size M
in the long run.
To produce more Q
QA QB
than QB, firm will
choose size L
in the long run.
 A Typical LRATC Curve
In the real
world, factories ATC
come in many
sizes, LRATC
each with its
own SRATC
curve.
So a typical
LRATC curve
looks like this: Q
How ATC Changes as the Scale of Production
Changes
Economies of ATC
scale: ATC falls
as Q increases.
LRATC
Constant
returns to
scale: ATC
stays the same
as Q increases.
Diseconomies Q
of scale: ATC
rises
as Q increases.
 The Revenue of a Competitive
Firm
Total revenue (TR) TR = P x Q

TR
Average revenue AR = =P
Q
(AR)
TR
Marginal Revenue MR =
Q
(MR):
The change in TR
from
selling one more
unit.
Thank you