Chapter 13: The Costs of Production

implicit costs

input costs that do not require an outlay of money by the firm

explicit costs

input costs that require an outlay of money by the firm

production function

the relationship between quantity of inputs used to make a good and the quantity of output of that good

average total cost

total cost divided by the quantity of output

profit

total revenue *minus* total cost

economic profit

total revenue minus total cost, including both explicit and implicit costs

accounting profit

total revenue minus total explicit cost

average variable cost

variable cost divided by the quantity of output

total revenue

the amount a firm receives for the sale of its output

marginal product

the increase in output that arises from an additional unit of input

marginal cost

the increase in total cost that arises from an extra unit of production

total cost

the market value of the inputs a firm uses in production

economies of scale

the property whereby long-run average total cost falls as the quantity of output increases

diseconomies of scale

the property whereby long-run average total cost rises as the quantity of output increases

constant returns to scale

the property whereby long-run average total cost stays the same as the quantity of output changes

diminishing marginal product

the property whereby the marginal product of an input declines as the quantity of the input increases

efficient scale

the quantity of output that minimizes average total cost

fixed costs

costs that do not vary with the quantity of output produced

variable costs

costs that vary with the quantity of output produced

average fixed cost

fixed cost divided by the quantity of output

Summary

• The 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 of the opportunity costs, such as the wages a firm pays its workers, are explicit. Other opportunity costs, such as the wages the firm owner gives up by working at the firm rather than taking another job, are implicit. Economic profit takes both explicit and implicit costs into account, whereas accounting profit considers only explicit costs. • A firm's costs reflect its production process. A typical firm's production function gets flatter as the quantity of an input increases, displaying the property of diminishing marginal product. As a result, a firm's total-cost curve gets steeper as the quantity produced rises. • A firm's total costs can be divided between fixed costs and variable costs. Fixed costs are costs that do not change when the firm alters the quantity of output produced. Variable costs are costs that change when the firm alters the quantity of output produced. • From a firm's total cost, two related measures of cost are derived. Average total cost is total cost divided by the quantity of output. Marginal cost is the amount by which total cost rises if output increases by . • When analyzing firm behavior, it is often useful to graph average total cost and marginal cost. For a typical firm, marginal cost rises with the quantity of output. Average total cost first falls as output increases and then rises as output increases further. The marginal-cost curve always crosses the average-total-cost curve at the minimum of average total cost. • A firm's costs often depend on the time horizon considered. In particular, many costs are fixed in the short run but variable in the long run. As a result, when the firm changes its level of production, average total cost may rise more in the short run than in the long run.