Principles of

Economics, 10e
Chapter 14: The Costs of
Production

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to a publicly accessible website, in whole or in part. 1
 Chapter Objectives (1 of 3)

By the end of this chapter, you should be able to:

• Calculate total revenue, given price and production data.
• Calculate total cost, given input costs and production data.
• Calculate profit, given price, input costs, and production data.
• Compare economic profit and accounting profit, given data on total revenue, implicit
costs, and explicit costs.
• Categorize a cost as explicit or implicit, given a scenario.
• Classify a firm's costs as fixed or variable.
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 Chapter Objectives (2 of 3)

• Given a graph of the production function and input costs, derive the firm's total-cost
curve.
• Derive total product, average product, and marginal product, given data on a firm's
production technology.
• Explain the concept of diminishing marginal product using a production function.
• Plot a production function for a firm, given its production data.
• Calculate a firm's various average costs at different quantities, given data on that firm's
cost structure.

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 Chapter Objectives (3 of 3)

• Calculate a firm's marginal cost at different quantities, given data on that firm's cost
structure.
• Explain the shapes of the ATC, AVC, AFC, and MC curves.
• Explain why a firm's marginal cost curve intersects the average-total-cost curve at its
minimum.
• Explain the relationship between short-run and long-run average total costs.
• Given a graph of the average-total-cost curve in the long run, identify the regions that
represent economies of scale, constant returns to scale, and diseconomies of scale.

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 14-1
What Are Costs?

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 Total Revenue, Total Cost, and Profit

• Total revenue*
• The amount a firm receives for the sale of its output
• Total cost*
• The market value of the inputs a firm uses in production
• Profit*
• Total revenue minus total cost

*Words accompanied by an asterisk are key terms from the chapter.

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 Why Opportunity Costs Matter

• Opportunity cost
• The cost of something is what you give up to get it
• Firm’s cost of production
• Includes all the opportunity costs of making its output of goods and services

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 Explicit and Implicit Costs

• Explicit costs*
• Input costs that require an outlay of money by the firm
• Implicit costs*
• Input costs that do not require an outlay of money by the firm
• Total Costs = Explicit costs + Implicit costs

*Words accompanied by an asterisk are key terms from the chapter.

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 The Cost of Capital Is An Opportunity Cost

• Implicit cost of almost every business is the opportunity cost of the money (financial
capital) that has been invested in it
• For example, economists view interest income given up as an implicit cost
• Accountants will not show this as a cost because no money flows out of the business
to pay for it

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 Economists and Accountants Measure Profit
Differently
• Economic profit*
• Total revenue minus total cost, including both explicit and implicit costs
• Accounting profit*
• Total revenue minus total explicit cost

*Words accompanied by an asterisk are key terms from the chapter.

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 Figure 1 Economists versus Accountants

• Because economists include all

opportunity costs when analyzing a
firm, while accountants measure
only explicit costs, economic profit
is smaller than accounting profit.

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Active Learning 1: Economic vs. Accounting Profit

• The equilibrium rent on office space has just increased by $500/month. Determine the
effects on accounting profit and economic profit if:
A. You rent your office space (you pay $500/month)
B. You own your office space

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 Active Learning 1: Answers

A. You rent your office space

• Explicit costs increase $500/month
• Accounting and economic profit each fall by $500/month

B. You own your office space

• Explicit costs do not change, so accounting profit does not change
• Implicit costs increase $500/month, so economic profit falls by $500/month

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 14-2
Production and Costs

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 The Production Function

• Production function*
• Relationship between the quantity of inputs used to make a good and the quantity of
output of that good
• Marginal product*
• The increase in output that arises from an additional unit of input

*Words accompanied by an asterisk are key terms from the chapter.

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 Diminishing Marginal Product

• Diminishing marginal product*

• The property whereby the marginal product of an input declines as the quantity of
the input increases
• Production function gets flatter as more inputs are being used
• The slope of the production function decreases

*Words accompanied by an asterisk are key terms from the chapter.

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 Table 1 A Production Function and Total Cost:
Chloe’s Cookie Factory
(1) (2) (3) (4) (5) (6)
Number of Output (quantity of Marginal Product Cost of Factory Cost of Workers Total Cost of
Workers cookies produced of Labor Inputs (cost of
per hour) factory plus cost of
workers)

0 0 $30 $0 $30
1 50 50 30 10 40
2 90 40 30 20 50
3 120 30 30 30 60
4 140 20 30 40 70
5 150 10 30 50 80
6 155 5 30 60 90

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 Figure 2 Chloe’s Production Function and Total-
Cost Curve (1 of 2)
• The production function in panel (a) shows the
relationship between the number of workers hired and
the quantity of output produced.
• Here, the number of workers hired (on the horizontal
axis) is from column (1) in Table 1, and the quantity of
output (on the vertical axis) is from column (2).
• The production function gets flatter as the number of
workers increases, reflecting diminishing marginal
product.

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 Figure 2 Chloe’s Production Function and Total-
Cost Curve (2 of 2)
• The total-cost curve in panel (b) shows the
relationship between the quantity of output and total
cost of production.
• Here, the quantity of output produced (on the
horizontal axis) is from column (2) in Table 1, and
the total cost (on the vertical axis) is from column
(6).
• The total-cost curve gets steeper as the quantity of
output increases because of diminishing marginal
product.
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to a publicly accessible website, in whole or in part. 19
 From the Production Function to the Total-Cost
Curve
• Total-cost curve
• Relationship between quantity produced and total costs
• As production rises
• Total-cost curve grows steeper
• Production function becomes flatter

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to a publicly accessible website, in whole or in part. 20
 Active Learning 2: Diminishing MPL

Number of Output MPL A. What is the marginal product of the

Workers second worker?
0 0 B. What is the marginal product of the
1 45 fourth worker?
2 85 C. Does this production function exhibits
3 115 diminishing marginal returns?
4 135
5 145

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to a publicly accessible website, in whole or in part. 21
 14-3
The Many Measures of Cost

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 Fixed and Variable Costs

• Fixed costs*
• Costs that do not vary with the quantity of output produced
• Variable costs*
• Costs that vary with the quantity of output produced
• Total cost = Fixed costs + Variable costs

*Words accompanied by an asterisk are key terms from the chapter.

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 Table 2 The Various Measures of Cost: Caleb’s Coffee
Shop
(1) (2) (3) (4) (5) (6) (7) (8)
Output (cups of Total Cost Fixed Cost Variable Cost Average Fixed Average Average Total Marginal Cost
coffee per hour) Cost Variable Cost Cost

0 $3.00 $3.00 $0.00

1 3.30 3.00 0.30 $3.00 $0.30 $3.30 $0.30
2 3.80 3.00 0.80 1.50 0.40 1.90 0.50
3 4.50 3.00 1.50 1.00 0.50 1.50 0.70
4 5.40 3.00 2.40 0.75 0.60 1.35 0.90
5 6.50 3.00 3.50 0.60 0.70 1.30 1.10
6 7.80 3.00 4.80 0.50 0.80 1.30 1.30
7 9.30 3.00 6.30 0.43 0.90 1.33 1.50
8 11.00 3.00 8.00 0.38 1.00 1.38 1.70
9 12.90 3.00 9.90 0.33 1.10 1.43 1.90
10 15.00 3.00 12.00 0.30 1.20 1.50 2.10

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 Figure 3 Caleb’s Total-Cost Curve

• Here, the quantity of output produced (on

the horizontal axis) is from column (1) in
Table 2, and the total cost (on the vertical
axis) is from column (2).
• As in Figure 2, the total-cost curve gets
steeper as the quantity of output increases,
reflecting diminishing marginal product.

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 Average and Marginal Cost (1 of 2)

• Average total cost*

• Total cost divided by the quantity of output

ATC = TC/Q
• Average fixed cost*
• Fixed cost divided by the quantity of output
• Average variable cost*
• Variable cost divided by the quantity of output
*Words accompanied by an asterisk are key terms from the chapter.

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to a publicly accessible website, in whole or in part. 26
 Average and Marginal Cost (2 of 2)

• Marginal cost*
• The increase in total cost that arises from an extra unit of production
• Marginal cost = Change in total cost/Change in quantity

MC = ΔTC/ΔQ

*Words accompanied by an asterisk are key terms from the chapter.

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to a publicly accessible website, in whole or in part. 27
 Cost Curves and Their Shapes

• Rising marginal cost

• Marginal cost rises as the quantity of output produced increases
• Upward slope reflects diminishing marginal product

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to a publicly accessible website, in whole or in part. 28
 Figure 4 Caleb’s Average-Cost and Marginal-Cost
Curves
• This figure shows the average total cost (ATC), average fixed
cost (AFC), average variable cost (AVC), and marginal cost
(MC) for Caleb’s Coffee Shop.

• These curves are all obtained by graphing the data in Table 2.

They show three common features:

(1) Marginal cost rises with the quantity of output.

(2) The average-total-cost curve is U-shaped.

(3) The marginal-cost curve crosses the average-total-cost

curve at the minimum of average total cost.

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 U-Shaped Average Total Cost

• Bottom of the U-shape occurs at the quantity that minimizes average total cost
• This quantity is sometimes called the efficient scale* of the firm
• When MC < ATC: Average total cost is falling
• When MC > ATC: Average total cost is rising
• The marginal-cost curve crosses the average-total-cost curve at its minimum

*Words accompanied by an asterisk are key terms from the chapter.

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 Typical Cost Curves

• Marginal cost eventually rises with the quantity of output

• Average-total-cost curve is U-shaped
• Marginal-cost curve crosses the average-total-cost curve at the minimum of average
total cost

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 Figure 5 Cost Curves for a Typical Firm

• Many firms experience increasing

marginal product before diminishing
marginal product. As a result, they have
cost curves shaped like those in this
figure.

• Notice that marginal cost and average

variable cost fall for a while before
starting to rise.

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to a publicly accessible website, in whole or in part. 32
 Active Learning 3: Calculating Costs

Q TC VC AFC AVC ATC MC

0 $50 n/a n/a n/a
1 10 $10 $60.00 $10
2 30 80
3 16.67 20 36.67 30
4 100 150 12.50 37.50
5 150 30
6 210 260 8.33 35 43.33 60

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to a publicly accessible website, in whole or in part. 33
 Active Learning 3: Answers

Q TC VC AFC AVC ATC MC

0 $0 $50 n/a n/a n/a
1 10 60 $50.00 $10 $60.00 $10
2 30 80 25.00 15 40.00 20
3 60 110 16.67 20 36.67 30
4 100 150 12.50 25 37.50 40
5 150 200 10.00 30 40.00 50
6 210 260 8.33 35 43.33 60

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to a publicly accessible website, in whole or in part. 34
 14-4
Costs in the Short Run and in the Long Run

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 The Relationship between Short-Run and Long-
Run Average Total Cost
• Many decisions are
• Fixed in the short run
• Variable in the long run
• Firms have greater flexibility in the long-run
• Long-run cost curves differ from short-run cost curves
• Much flatter than short-run cost curves
• Short-run cost curves
• Lie on or above the long-run cost curves
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Figure 6 Average Total Cost in the Short and Long
Runs
• Because fixed costs are variable in the
long run, the average-total-cost curve in
the short run differs from the average-
total-cost curve in the long run.

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to a publicly accessible website, in whole or in part. 37
 Economies and Diseconomies of Scale

• Economies of scale*
• Long-run average total cost falls as the quantity of output increases
• Constant returns to scale*
• Long-run average total cost stays the same as the quantity of output changes
• Diseconomies of scale*
• Long-run average total cost rises as the quantity of output increases

*Words accompanied by an asterisk are key terms from the chapter.

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 14-5
Conclusion

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Table 3 The Many Types of Cost: A Summary (1 of
2)
Term Definition Mathematical Description
Explicit costs Costs that require an outlay of money by
the firm
Implicit costs Costs that do not require an outlay of
money by the firm
Fixed costs Costs that do not vary with the quantity FC
of output produced
Variable costs Costs that vary with the quantity of VC
output produced
Total cost The market value of all the inputs that a TC = FC + VC
firm uses in production

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Table 3 The Many Types of Cost: A Summary (2 of
2)
Term Definition Mathematical Description
Average fixed cost Fixed cost divided by the quantity AFC = FC/Q
of output

Average variable cost Variable cost divided by the AVC = VC/Q

quantity of output

Average total cost Total cost divided by the quantity ATC = TC/Q
of output

Marginal cost The increase in total cost that MC =  ΔTC/ΔQ

arises from an extra unit of
production

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 Think-Pair-Share Activity

Your neighbor has a back-yard garden and grows fresh fruit and vegetables to be sold at a
local “farmer’s market.” He comments, “I hired a college student who was on summer
vacation to help me this summer and my production more than doubled. Next summer, I
think I’ll hire three helpers and my output should go up more than three- or fourfold.”
A. What can explain why the production more than doubled when your neighbor hired a
helper?
B. Will production increase three- or fourfold if your neighbor hires 3 helpers next
summer?

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 Self-Assessment 

• When analyzing a firm’s behavior, why is it important to include all the opportunity
costs of production?

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 Summary

Click the link to review the objectives for this presentation.

Link to Objectives

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