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Cost Of Production

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Kevin A
Kevin A

This chapter discusses the costs of production for firms. It will examine what costs are included in a firm's total costs, how costs are related to the production process and output quantity, and the meaning of average and marginal costs. The chapter analyzes cost concepts like total, average, and marginal costs. It also discusses the relationship between costs and a firm's production function as well as the differences between fixed and variable costs.

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Chapter 13The Cost of Production
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 2Examine what items are included in a firm’s costs of production.Analyze the link between a firm’s production process and its total costs.Learn the meaning of average total cost and marginal cost and how they are related.Consider the shape of a typical firm’s cost curves.Examine the relationship between short-run and long run costs. In this chapter you will…
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 3Supplyand demand are the two words that economists use most often.Supplyand demandare the forces that make market economies work.Modern microeconomics is about supply, demand, and market equilibrium.THE COSTS OF PRODUCTION
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 4According to the Law of Supply:Firms are willing to produce and sell a greater quantity of a good when the price of the good is high.This results in a supply curve that slopes upward.The Firm’s ObjectiveThe economic goal of the firm is to maximize profits.THE COSTS OF PRODUCTION
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 5Total RevenueThe amount a firm receives for the sale of its output.Total CostThe market value of the inputs a firm uses in production.Profit The firm’s total revenue minus its total cost.Profit = Total revenue - Total costTotal Revenue, Total Costs, and Profit
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 6A firm’s cost of production includes all the opportunity costs of making its output of goods and services.Explicit and Implicit CostsA firm’s cost of production include explicit costs and implicit costs.Explicit costs are input costs that require a direct outlay of money by the firm. Implicit costs are input costs that do not require an outlay of money by the firm.Cost as an Opportunity Cost
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 7Example:Helen uses $300 000 of her savings to buy her cookie factory from the previous owner.If she had left her money in a savings account that pays an interest at a rate of 5 percent, she would have earned $15 000 a year. Helen by buying a cookie factory has foregone $15 000 a year in interest income.This foregone $15 000 is an implicit opportunity cost of Helen’s business. The accountant will not show this cost.Cost as an Opportunity Cost
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 8Economists measure a firm’s economic profitas total revenue minus total cost, including both explicit and implicit costs.Accountants measure the accounting profitas the firm’s total revenue minus only the firm’s explicit costs. Economic Profit versus Accounting Profit
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 9When total revenue exceeds both explicit and implicit costs, the firm earns economicprofit.Economic profit is smaller than accounting profit.Economic Profit Versus Accounting Profit
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 10RevenueRevenueTotal Opportunity CostsFigure 13-1: Economists versus AccountantsHow an Accountant Views a FirmHow an Economist Views a FirmAccounting profitEconomic profitImplicit costsExplicit costsExplicit costs
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 11Assumption: The size of Helen’s cookie factory is fixed and the quantity of cookies produced can only vary by changing the number of workers. This assumption is realistic in the short-run but not the long-run.PRODUCTION AND COSTS
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 12$30$0$30050401030504050203090306030301202070403014010805030150Table 13-1: A Production Function and Total Cost: Hungry Helen’s Cookie FactoryTotal cost of inputs (cost of factory + cost of workers)Cost of workerCost of factoryMarginal product of labourOutput (quantity of cookies produced per hour)Number of workers012345
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 13The Production FunctionThe production functionshows the relationship between quantity of inputs used to make a good and the quantity of output of that good.Marginal ProductThe marginal productof any input in the production process is the increase in output that arises from an additional unit of that input.PRODUCTION AND COSTS
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 14Diminishing Marginal ProductDiminishing marginal productis the property whereby the marginal product of an input declines as the quantity of the input increases. Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment. PRODUCTION AND COSTS
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 151501401209050Figure 13-2: Hungry Helen’s Production FunctionQuantity of Output (cookies per hour)Production function104235Number of Workers Hired
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 16Diminishing Marginal ProductDiminishing marginal productis the property whereby the marginal product of an input declines as the quantity of the input increases. Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment. PRODUCTION AND COSTS
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 17Diminishing Marginal ProductThe slope of the production function measures the marginal product of an input, such as a worker.When the marginal product declines, the production function becomes flatter.PRODUCTION AND COSTS
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 18The relationship between the quantity a firm can produce and its costs determines pricing decisions. See last three columns in Table 13-1.The total-cost curve shows this relationship graphically. From the Production Function to the Total-Cost Curve
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 19$30$0$30050401030504050203090306030301202070403014010805030150Table 13-1: A Production Function and Total Cost: Hungry Helen’s Cookie FactoryTotal cost of inputs (cost of factory + cost of workers)Cost of workerCost of factoryMarginal product of labourOutput (quantity of cookies produced per hour)Number of workers012345
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 20$8070605040305012014015090Figure 13-3: Hungry Helen’s Total-Cost CurveTotal Cost Total-cost curve0Quantity of Output (cookies per hour)
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 21Costs of production may be divided into fixed costsand variable costs.Fixed costs are those costs that do notvary with the quantity of output produced.Variable costs are those costs that do varywith the quantity of output produced.THE VARIOUS MEASURES OF COST
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 22Total CostsTotal Fixed Costs (TFC)Total Variable Costs (TVC)Total Costs (TC) TC = TFC + TVCTHE VARIOUS MEASURES OF COST
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 23Average CostsAverage costs can be determined by dividing the firm’s costs by the quantity of output it produces. The average cost is the cost of each typical unit of product. THE VARIOUS MEASURES OF COST
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 24Average CostsAverage Fixed Costs (AFC) = ATC / QAverage Variable Costs (AVC) = AVC / QAverage Total Costs (ATC) = ATC / QATC = AFC + AVCTHE VARIOUS MEASURES OF COST
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 25Marginal CostMarginal cost(MC) measures the increase in total cost that arises from an extra unit of production.Marginal cost helps answer the following question:How much does it cost to produce an additional unit of output?THE VARIOUS MEASURES OF COST
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 26Marginal CostMarginal cost(MC) measures the increase in total cost that arises from an extra unit of production.Marginal cost helps answer the following question:How much does it cost to produce an additional unit of output?THE VARIOUS MEASURES OF COST
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 27---------------------------$ 0.00$ 3.00$ 3.0000.30$ 3.30$ 0.30 $ 3.000.303.003.3010.501.900.401.500.803.003.8020.701.500.501.001.503.004.5030.901.350.600.752.403.005.4041.101.300.700.603.503.006.5051.301.300.800.504.803.007.8061.501.330.900.436.303.009.3071.701.381.000.388.003.0011.0081.901.431.100.339.903.0012.9092.101.501.200.3012.003.0015.0010Table 13-2: The Various Measures of Cost: Thirsty Thelma’s Lemonade StandMarginal CostAverage Total CostAverage Variable CostAverage Fixed CostVariable CostFixed CostTotal CostQuantity of lemonade (Glasses per hour)
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 2815.0011.005.403.008100Figure 13-4: Thirsty Thelma’s Total-Cost CurveTotal Cost Total-cost curve4Quantity of Output (glasses of lemonade per hour)
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 29Cost Curves and their ShapesThe cost curves shown here for Thirsty Thelma’s Lemonade Stand have some features that are common to the cost curves of many firms in the economy.Lets examine three features in particular:The shape of the marginal cost curveThe shape of the average cost curveThe relationship between marginal and average total cost
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 30MCATCAVC1.30AFCFigure 13-5: Thirsty Thelma’s Average-Cost and Marginal-Cost CurvesCosts 3.303.00054321610789Quantity of Output (glasses of lemonade per hour)
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 31Marginal cost rises with the amount of output produced.This reflects the property of diminishing marginal product. The average total-cost curve is U-shaped.At very low levels of output average total cost is high because fixed cost is spread over only a few units.Average total cost declines as output increases.Average total cost starts rising because average variable cost rises substantially.Cost Curves and their Shapes
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 32Cost Curves and their ShapesThe bottom of the U-shaped ATC curve occurs at the quantity that minimizes average total cost. This quantity is sometimes called the efficient scaleof the firm.Relationship between Marginal Cost and Average Total CostWhenever marginal cost is less than average total cost, average total cost is falling.Whenever marginal cost is greater than average total cost, average total cost is rising.The marginal-cost curve crosses the average-total-cost curve at the efficient scale.
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 33Typical Cost CurvesIn the previous examples, the firms exhibit diminishing marginal product and, therefore, rising marginal cost at all levels of output. Actual firms are often a bit more complicated than this. E.g., diminishing marginal product does not start after the first worker id hired. Table 13-3 shows such a firm.
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 34---------------------------$ 0.00$ 2.00$ 2.0001.00$ 3.00$ 1.00 $ 2.001.002.003.0010.801.900.901.001.802.003.8020.601.470.800.672.402.004.4030.401.200.700.502.802.005.2040.401.040.640.403.202.005.8050.600.960.630.333.802.006.6060.800.950.660.294.602.007.6071.000.980.700.255.602.008.8081.201.020.760.226.802.0010.2091.401.070.820.208.202.0011.8010Table 13-3: The Various Measures of Cost: Big Bob’s Bagel BinMarginal CostAverage Total CostAverage Variable CostAverage Fixed CostVariable CostFixed CostTotal CostQuantity of lBagels (per hour)
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 35Figure 13-6a): Big Bob’s Cost Curves(a) Total-Cost CurveTotalCostTC$18.0016.0014.0012.0010.008.006.004.002.0042681412100Quantity of Output (bagels per hour)Copyright © 2004 South-Western
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 36Figure 13-6b): Big Bob’s Cost Curves(b) Marginal- and Average-Cost CurvesCosts$3.002.50MC2.001.50ATCAVC1.000.50AFC04268141210Quantity of Output (bagels per hour)Copyright © 2004 South-Western
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 37Typical Cost CurvesThree Important Properties of Cost CurvesMarginal cost eventually rises with the quantity of output.The average-total-cost curve is U-shaped.The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 38THE RELATIONSHIP BETWEEN THE SHORT RUN AND THE LONG RUNFor many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.In the short run, some costs are fixed.In the long run, fixed costs become variable costs.Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.
ATC in shortATC in shortATC in shortrun withrun withrun withsmall factorymedium factorylarge factoryATC in long runFigure 13-7: Average Total Cost in the Short and Long RunsAverageTotalCost$12,000Quantity of01,200Cars per Day
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 40Economies and Diseconomies of ScaleEconomies of scalerefer to the property whereby long-run average total cost falls as the quantity of output increases.Diseconomies of scalerefer to the property whereby long-run average total cost rises as the quantity of output increases.Constant returns to scalerefers to the property whereby long-run average total cost stays the same as the quantity of output increases
Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 41SummaryThe goal of firms is to maximize profit, which equals total revenue minus total cost.
When analyzing a firm’s behavior, it is important to include all the opportunity costs of production.
Some opportunity costs are explicit while other opportunity costs are implicit.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 42SummaryA firm’s costs reflect its production process.
A typical firm’s production function gets flatter as the quantity of input increases, displaying the property of diminishing marginal product.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 43SummaryA firm’s total costs are divided between fixed and variable costs. Fixed costs do not change when the firm alters the quantity of output produced; variable costs do change as the firm alters quantity of output produced.
Average total cost is total cost divided by the quantity of output.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 44SummaryMarginal cost is the amount by which total cost would rise if output were increased by one unit.
The marginal cost always rises with the quantity of output.

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Cost Of Production

  • 1. Chapter 13The Cost of Production
  • 2. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 2Examine what items are included in a firm’s costs of production.Analyze the link between a firm’s production process and its total costs.Learn the meaning of average total cost and marginal cost and how they are related.Consider the shape of a typical firm’s cost curves.Examine the relationship between short-run and long run costs. In this chapter you will…
  • 3. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 3Supplyand demand are the two words that economists use most often.Supplyand demandare the forces that make market economies work.Modern microeconomics is about supply, demand, and market equilibrium.THE COSTS OF PRODUCTION
  • 4. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 4According to the Law of Supply:Firms are willing to produce and sell a greater quantity of a good when the price of the good is high.This results in a supply curve that slopes upward.The Firm’s ObjectiveThe economic goal of the firm is to maximize profits.THE COSTS OF PRODUCTION
  • 5. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 5Total RevenueThe amount a firm receives for the sale of its output.Total CostThe market value of the inputs a firm uses in production.Profit The firm’s total revenue minus its total cost.Profit = Total revenue - Total costTotal Revenue, Total Costs, and Profit
  • 6. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 6A firm’s cost of production includes all the opportunity costs of making its output of goods and services.Explicit and Implicit CostsA firm’s cost of production include explicit costs and implicit costs.Explicit costs are input costs that require a direct outlay of money by the firm. Implicit costs are input costs that do not require an outlay of money by the firm.Cost as an Opportunity Cost
  • 7. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 7Example:Helen uses $300 000 of her savings to buy her cookie factory from the previous owner.If she had left her money in a savings account that pays an interest at a rate of 5 percent, she would have earned $15 000 a year. Helen by buying a cookie factory has foregone $15 000 a year in interest income.This foregone $15 000 is an implicit opportunity cost of Helen’s business. The accountant will not show this cost.Cost as an Opportunity Cost
  • 8. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 8Economists measure a firm’s economic profitas total revenue minus total cost, including both explicit and implicit costs.Accountants measure the accounting profitas the firm’s total revenue minus only the firm’s explicit costs. Economic Profit versus Accounting Profit
  • 9. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 9When total revenue exceeds both explicit and implicit costs, the firm earns economicprofit.Economic profit is smaller than accounting profit.Economic Profit Versus Accounting Profit
  • 10. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 10RevenueRevenueTotal Opportunity CostsFigure 13-1: Economists versus AccountantsHow an Accountant Views a FirmHow an Economist Views a FirmAccounting profitEconomic profitImplicit costsExplicit costsExplicit costs
  • 11. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 11Assumption: The size of Helen’s cookie factory is fixed and the quantity of cookies produced can only vary by changing the number of workers. This assumption is realistic in the short-run but not the long-run.PRODUCTION AND COSTS
  • 12. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 12$30$0$30050401030504050203090306030301202070403014010805030150Table 13-1: A Production Function and Total Cost: Hungry Helen’s Cookie FactoryTotal cost of inputs (cost of factory + cost of workers)Cost of workerCost of factoryMarginal product of labourOutput (quantity of cookies produced per hour)Number of workers012345
  • 13. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 13The Production FunctionThe production functionshows the relationship between quantity of inputs used to make a good and the quantity of output of that good.Marginal ProductThe marginal productof any input in the production process is the increase in output that arises from an additional unit of that input.PRODUCTION AND COSTS
  • 14. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 14Diminishing Marginal ProductDiminishing marginal productis the property whereby the marginal product of an input declines as the quantity of the input increases. Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment. PRODUCTION AND COSTS
  • 15. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 151501401209050Figure 13-2: Hungry Helen’s Production FunctionQuantity of Output (cookies per hour)Production function104235Number of Workers Hired
  • 16. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 16Diminishing Marginal ProductDiminishing marginal productis the property whereby the marginal product of an input declines as the quantity of the input increases. Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment. PRODUCTION AND COSTS
  • 17. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 17Diminishing Marginal ProductThe slope of the production function measures the marginal product of an input, such as a worker.When the marginal product declines, the production function becomes flatter.PRODUCTION AND COSTS
  • 18. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 18The relationship between the quantity a firm can produce and its costs determines pricing decisions. See last three columns in Table 13-1.The total-cost curve shows this relationship graphically. From the Production Function to the Total-Cost Curve
  • 19. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 19$30$0$30050401030504050203090306030301202070403014010805030150Table 13-1: A Production Function and Total Cost: Hungry Helen’s Cookie FactoryTotal cost of inputs (cost of factory + cost of workers)Cost of workerCost of factoryMarginal product of labourOutput (quantity of cookies produced per hour)Number of workers012345
  • 20. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 20$8070605040305012014015090Figure 13-3: Hungry Helen’s Total-Cost CurveTotal Cost Total-cost curve0Quantity of Output (cookies per hour)
  • 21. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 21Costs of production may be divided into fixed costsand variable costs.Fixed costs are those costs that do notvary with the quantity of output produced.Variable costs are those costs that do varywith the quantity of output produced.THE VARIOUS MEASURES OF COST
  • 22. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 22Total CostsTotal Fixed Costs (TFC)Total Variable Costs (TVC)Total Costs (TC) TC = TFC + TVCTHE VARIOUS MEASURES OF COST
  • 23. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 23Average CostsAverage costs can be determined by dividing the firm’s costs by the quantity of output it produces. The average cost is the cost of each typical unit of product. THE VARIOUS MEASURES OF COST
  • 24. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 24Average CostsAverage Fixed Costs (AFC) = ATC / QAverage Variable Costs (AVC) = AVC / QAverage Total Costs (ATC) = ATC / QATC = AFC + AVCTHE VARIOUS MEASURES OF COST
  • 25. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 25Marginal CostMarginal cost(MC) measures the increase in total cost that arises from an extra unit of production.Marginal cost helps answer the following question:How much does it cost to produce an additional unit of output?THE VARIOUS MEASURES OF COST
  • 26. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 26Marginal CostMarginal cost(MC) measures the increase in total cost that arises from an extra unit of production.Marginal cost helps answer the following question:How much does it cost to produce an additional unit of output?THE VARIOUS MEASURES OF COST
  • 27. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 27---------------------------$ 0.00$ 3.00$ 3.0000.30$ 3.30$ 0.30 $ 3.000.303.003.3010.501.900.401.500.803.003.8020.701.500.501.001.503.004.5030.901.350.600.752.403.005.4041.101.300.700.603.503.006.5051.301.300.800.504.803.007.8061.501.330.900.436.303.009.3071.701.381.000.388.003.0011.0081.901.431.100.339.903.0012.9092.101.501.200.3012.003.0015.0010Table 13-2: The Various Measures of Cost: Thirsty Thelma’s Lemonade StandMarginal CostAverage Total CostAverage Variable CostAverage Fixed CostVariable CostFixed CostTotal CostQuantity of lemonade (Glasses per hour)
  • 28. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 2815.0011.005.403.008100Figure 13-4: Thirsty Thelma’s Total-Cost CurveTotal Cost Total-cost curve4Quantity of Output (glasses of lemonade per hour)
  • 29. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 29Cost Curves and their ShapesThe cost curves shown here for Thirsty Thelma’s Lemonade Stand have some features that are common to the cost curves of many firms in the economy.Lets examine three features in particular:The shape of the marginal cost curveThe shape of the average cost curveThe relationship between marginal and average total cost
  • 30. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 30MCATCAVC1.30AFCFigure 13-5: Thirsty Thelma’s Average-Cost and Marginal-Cost CurvesCosts 3.303.00054321610789Quantity of Output (glasses of lemonade per hour)
  • 31. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 31Marginal cost rises with the amount of output produced.This reflects the property of diminishing marginal product. The average total-cost curve is U-shaped.At very low levels of output average total cost is high because fixed cost is spread over only a few units.Average total cost declines as output increases.Average total cost starts rising because average variable cost rises substantially.Cost Curves and their Shapes
  • 32. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 32Cost Curves and their ShapesThe bottom of the U-shaped ATC curve occurs at the quantity that minimizes average total cost. This quantity is sometimes called the efficient scaleof the firm.Relationship between Marginal Cost and Average Total CostWhenever marginal cost is less than average total cost, average total cost is falling.Whenever marginal cost is greater than average total cost, average total cost is rising.The marginal-cost curve crosses the average-total-cost curve at the efficient scale.
  • 33. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 33Typical Cost CurvesIn the previous examples, the firms exhibit diminishing marginal product and, therefore, rising marginal cost at all levels of output. Actual firms are often a bit more complicated than this. E.g., diminishing marginal product does not start after the first worker id hired. Table 13-3 shows such a firm.
  • 34. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 34---------------------------$ 0.00$ 2.00$ 2.0001.00$ 3.00$ 1.00 $ 2.001.002.003.0010.801.900.901.001.802.003.8020.601.470.800.672.402.004.4030.401.200.700.502.802.005.2040.401.040.640.403.202.005.8050.600.960.630.333.802.006.6060.800.950.660.294.602.007.6071.000.980.700.255.602.008.8081.201.020.760.226.802.0010.2091.401.070.820.208.202.0011.8010Table 13-3: The Various Measures of Cost: Big Bob’s Bagel BinMarginal CostAverage Total CostAverage Variable CostAverage Fixed CostVariable CostFixed CostTotal CostQuantity of lBagels (per hour)
  • 35. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 35Figure 13-6a): Big Bob’s Cost Curves(a) Total-Cost CurveTotalCostTC$18.0016.0014.0012.0010.008.006.004.002.0042681412100Quantity of Output (bagels per hour)Copyright © 2004 South-Western
  • 36. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 36Figure 13-6b): Big Bob’s Cost Curves(b) Marginal- and Average-Cost CurvesCosts$3.002.50MC2.001.50ATCAVC1.000.50AFC04268141210Quantity of Output (bagels per hour)Copyright © 2004 South-Western
  • 37. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 37Typical Cost CurvesThree Important Properties of Cost CurvesMarginal cost eventually rises with the quantity of output.The average-total-cost curve is U-shaped.The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.
  • 38. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 38THE RELATIONSHIP BETWEEN THE SHORT RUN AND THE LONG RUNFor many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.In the short run, some costs are fixed.In the long run, fixed costs become variable costs.Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.
  • 39. ATC in shortATC in shortATC in shortrun withrun withrun withsmall factorymedium factorylarge factoryATC in long runFigure 13-7: Average Total Cost in the Short and Long RunsAverageTotalCost$12,000Quantity of01,200Cars per Day
  • 40. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 40Economies and Diseconomies of ScaleEconomies of scalerefer to the property whereby long-run average total cost falls as the quantity of output increases.Diseconomies of scalerefer to the property whereby long-run average total cost rises as the quantity of output increases.Constant returns to scalerefers to the property whereby long-run average total cost stays the same as the quantity of output increases
  • 41. Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 41SummaryThe goal of firms is to maximize profit, which equals total revenue minus total cost.
  • 42. When analyzing a firm’s behavior, it is important to include all the opportunity costs of production.
  • 43. Some opportunity costs are explicit while other opportunity costs are implicit.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 42SummaryA firm’s costs reflect its production process.
  • 44. A typical firm’s production function gets flatter as the quantity of input increases, displaying the property of diminishing marginal product.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 43SummaryA firm’s total costs are divided between fixed and variable costs. Fixed costs do not change when the firm alters the quantity of output produced; variable costs do change as the firm alters quantity of output produced.
  • 45. Average total cost is total cost divided by the quantity of output.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 44SummaryMarginal cost is the amount by which total cost would rise if output were increased by one unit.
  • 46. The marginal cost always rises with the quantity of output.
  • 47. Average cost first falls as output increases and then rises.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 45SummaryThe average-total-cost curve is U-shaped.
  • 48. The marginal-cost curve always crosses the average-total-cost curve at the minimum of ATC.
  • 49. A firm’s costs often depend on the time horizon being considered.
  • 50. In particular, many costs are fixed in the short run but variable in the long run.Mankiw et al. Principles of Microeconomics, 2nd Canadian EditionChapter 13: Page 46The End