FOUNDATION COURSE
IN MANAGERIAL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur
Lecture 15: Costs of Production
Concepts that we learn and use here
• Economic Profit and Accounting Profit
• Production function and marginal product
• Various types of costs and how they are related to each
other
• Does cost decision of firm change over time? How are
costs different in short and long run?
• Economies of scale
Revenue, Cost and Profit
• Profit = Total Revenue – Total Cost
Assumption: Firms’ objective is to maximize profits
• Costs : Explicit and Implicit Costs
• Explicit costs: Direct costs incurred by the producer which he
has to pay for in money terms, also known as Accounting costs
• Implicit Costs: Value foregone of resources used, which could
have been used in other alternatives, also known as
Opportunity costs
Economic cost = Explicit cost + Implicit cost
Economic Profit
• Economic Profit = Total revenue – Explicit cost – Implicit
Cost
• Zero Economic Profit is a Normal Accounting Profit
FOUNDATION COURSE
IN MANAGERIAL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur
Lecture 16: Production Function and Marginal Product
Production Function
•
Marginal Product
• MP of any input diminishes as more and more units of the input
are added, keeping other inputs constant.
• Diminishing marginal product:
the marginal product of an input declines as the quantity of the
input increases (other things equal)
• MP is important to the producer in deciding if he should add an
additional input for production
• If he hires an additional labour, his cost rises by the wage he
pays to the labour and his output rises by MPL
FOUNDATION COURSE
IN MANAGERIAL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur
Lecture 17: Cost curves
Different type of costs
• Fixed costs – Fixed costs do not vary with quantity of
output produced
• Variable costs – Variable costs vary with quantity of output
produced
• Total Cost = Fixed costs + Variable costs
Cost curves
•
FOUNDATION COURSE
IN MANAGERIAL
ECONOMICS
Dr Barnali Nag
IIT Kharagpur
Lecture 18: Cost curves in the Long run and Short run
Difference between Long Run and Short Run
• Short run: Some inputs require some time to increase or decrease in
amount. The amount of time for which they are fixed is known as the
short run.
• Example: Plant size, land, large machineries
• Long run: The amount of time required to increase or decrease the
amount of all inputs is called the long run. In the long run all inputs are
flexible.
• Example: It is possible to set up more factories or buy or sell land, machineries
etc. in the long run
• In the long run, to produce any level of output, a firm will choose that mix
of inputs for which its average total cost is minimum, i.e. the firm will
choose the most efficient mix of inputs for any level of output
Economies of Scale
• The long run average total cost curve is u shaped because of economies of
scale
• At low levels of output, with increase in output, average cost falls because of
economies of scale
• Example: There is more learning by doing, increased specialization and efficiency
improvement as production increases
• Constant returns to scale happens when average cost stays the same even as
output increases
• At very high levels of production, with increase in output, average cost may
actually rise because of diseconomies of scale
• Example: Coordination problems, increase in complexities and managerial
inefficiencies in larger size firms with high levels of output.
