Chapter 3: The costs of production

AFC = TFC/Y

AFC = Payments to fixed factors per unit of output; decline as more output is produced because fixed payments are spread over more units of output

ATC = TC/Y

ATC = total costs divided by entire input; decrease then increase

Total costs include two types

Accounting Costs and Opportunity Costs

A constant cost firm faces constant production costs for all units of output produced

First unit of output produced costs the same as the last unit of output produced; Example: feedlot; AC is equal to the marginal costs

Similarly, the marginal cost curve is inversely related to the

MPP curve.

AC

TC/Y

TC =

TFC + TVC

The more output the firm produces and sells, the higher the level of

TR.

Accounting Profits (π_A) =

Total Revenue (TR) minus Explicit Costs or Total Accounting Costs (TC_A); *Do not consider* opportunity costs; the sum of all of the payments made for the inputs used

Economic Profits (π_E) =

Total Revenue (TR) minus Total Accounting Cost (TC_A) minus opportunity costs

Profits (π) =

Total Revenue (TR) minus Total Cost (TC)

Profits (π)=

Total Revenue (TR) minus Total Cost (TC)

Profits equal

Total Revenue minus Total Costs.

AVC = TVC/Y

Total costs (TVC) divided by the level of output (TVC/Y); same pattern as ATC curve

Marginal cost is the

additional cost of producing one more unit of output.

The relationship between one input and output is isolated while holding

all other inputs constant, ceteris peribus; Y = f[X1 | X2...Xn]

A firm's cost curves reflect a firm's productivity

an increase in productivity is identical to a decrease in costs.

Total Costs rise with increasing levels of output; but, due to the law of diminishing marginal returns, costs rise at

an increasing rate; Means that production process will at some point become less productive and more costly

The relationship between average and marginal costs is the same as the relationship between

average and marginal physical products.

Average total costs (ATC) provide calculation of

average cost of producing a single unit of output

If MC is less than AC, then

average costs are decreasing.

Economic costs include

both accounting costs and opportunity costs; TC_E = TC_A + opportunity costs

In economics, total costs (TC) always includes

both the accounting (or explicit) costs, and the opportunity costs, or what must be given up to use the resources

MC =

change in TC divided by the change in Y

TVC

change with the level of output; increase as output increases

Corn producers interested in maximizing profits should

consider both costs and revenue.

A constant cost firm faces

constant production costs for all units of output produced.

The level of output produced by a firm and the costs of producing that output

costs of production

Decreasing costs occur when the per unit costs of a firm's output

decline as output increases; MC curve always lies below the AC curve; AC curve is always declining; Walmart

• An increase in productivity (increase in APP) occurs along with a

decrease in costs (decrease in ATC).

A firm with typical cost curves is one whose average costs

decrease then increase.

A decreasing cost firm has per unit costs that

decreases as output increases.

The typical cost curve involves all three types of costs

decreasing AC, constant AC, and increasing AC

A typical production process has TVC increase at a

decreasing rate and then at an increasing rate

Example of short run

difficult to change the size of farm in short period of time but variable inputs such as chemicals, labor, fertilizer, seed, machinery are easy to change even in short period of time

A typical total cost curve increases at a decreasing rate, and then increases at an increasing rate, as what sets in?

diminishing marginal returns

Fixed costs

do not vary with output; Must be paid in full; such as Rent, loan, taxes; DO NOT VARY WITH THE LEVEL OF OUTPUT.

TFC

do not vary with output; constant

Fixed costs are those costs that

do not vary with the level of output; the costs associated with the fixed factors of production

When all resources are earning their opportunity costs, economic profits are equal to zero, and the resources are

earning as much as they are worth.

Accounting costs include

electricity payments, payment to hired workers, and fertilizer costs, NOT how much the operator could earn as a plumber.

Accounting costs

explicit costs, or payments that a business firm must actually make in order to obtain factors of production; explicit costs of production; costs for which payments are required; Accountants, bookkeepers

Average fixed costs are

fixed costs divided by the level of output.

Scarcity

having less than the desired quantity of something

Total Revenue

how much money a firm earns from the sale of its output, Y; number of units of output, Y, times the per unit price of the output, P; TR = P times Y; Units in dollars

The average chases the marginal; so, if MC is greater than AC, then AC is increasing in other words

if MC is larger than AC, it pulls AC up.

The average chases the marginal; so, if MC is less than AC, then AC is decreasing; in other words

if MC is less than AC, then it pulls the AC down.

An increasing cost firm is one whose per unit cost of production

increases with increases in output; Firms that extract natural resources; The cost of extracting the resource increases as extraction increases because the lowest cost resources are used first, with costs increasing as more resource is extracted or used; MC curve is everywhere above the AC curve; AC curve continues to increase; the average chases the marginal.

An increasing cost firm has

increasing per unit costs as output increase.

The slope of the TVC curve eventually begins to increase at an increasing rate,

indicating adherence to the law of diminishing marginal returns

A firm should not always strive to produce the highest level of output because

it is costly and doesn't always mean highest level of profit

Fixed costs are payments to factors like

land or machines that are fixed in quantity in the short run

Average fixed cost declines with

larger quantities of production; More output results in lower per unit costs

An efficient firm will have_________________than a less efficient firm.

lower per-unit costs of production

Economic costs include

opportunity costs.

Variable costs are

payments to factors whose quantity may change in the short run such as chemicals labor, and fuel

Average costs

per unit costs; Dividing total costs (TC) by level of output (Y) yields average costs

Short run

period of time during which the quantity of at least one resource is variable

The production function is the

physical relationship between inputs (X) and output (Y); Y = f[X1, X2,...,Xn]

Slope of variable cost curve is

positive, but decreases in the range of output near the origin; Reflects increasing productivity of a production process as more inputs are added initially

Costs of production are directly related to the_____________ of a firm.

productivity

Producer should determine level of input use and compare benefits of the input to the costs of purchasing and applying it; if the benefits of using one more unit of input are greater than the cost of the input, it is

profitable to use it.

The major motivating force behind all market based economic behavior is

profits

From an economist's point of view, emphasis should center on

profits rather than yield; Costs too much to achieve maximum yield

Assumption: the goal of a business enterprise in a market based economy is to maximize

profits; applies to all firms, small or large

Production of good or service transforms inputs into outputs; these inputs require payments because they are

scarce.

Production function

shows the physical relationship between inputs and outputs.

Some farmers and ranchers remain in agriculture, even if they are earning negative economic profits

since they prefer a career in farming or ranching, even if it pays less than what they could earn in a different occupation.

Marginal costs

the added cost of producing one more unit of output; "do the benefits of producing one more unit of output outweigh the added costs?;" the increase in total costs due to the production of one more unit of output; [MC] = ∆TC/∆Y; dollars/unit of output

Average fixed costs

the average cost of the fixed costs per unit of output; [AFC] = TFC/Y; dollars

Average variable costs

the average cost of the variable costs per unit of output; [AVC] = TVC/Y; dollars

If MC is greater than AC, then

the average costs are increasing

Accounting costs are

the explicit costs of production.

Costs of production increase with increased output, since

the increase requires additional input; Added inputs are scarce and incur costs

Total fixed costs do not vary with

the level of output.

All resources have opportunity costs associated with them; the opportunity cost of planting one acre of land to cotton is

the money lost by not planting the next-best alternative crop on that land.

Total costs are

the payments paid to acquire factors of production.

Costs of production are also known as

the payments that a firm must make to purchase inputs (resources, factors).

Total Cost

the payments that a firm must make to purchase the factors production

Total Revenue (Price*Output) is an increasing, linear function of output because

the price of output is constant (USD/Y)

Total Revenue equals

the product price times the level of output

Economic Profits are also known as

the pure profit left over after the opportunity costs of all inputs are subtracted from total revenue

Total costs

the sum of all payments that a firm must make to purchase the factors of production, the sum of Total Fixed Costs and Total Variable Costs

Total Costs (TC) are

the sum of total fixed costs (TFC) and total variable costs (TVC) at any given level of output

Total fixed costs

the total costs of inputs that do not vary with the level of output [TFC]

Total variable costs (TVC)

the total costs of inputs that vary with the level of output [TVC]

The sum of all payments for inputs describes

the total costs that a firm must pay to produce a given quantity of a good.

The inverse relationship of the average and marginal product curves and the average and marginal cost curves demonstrates that

the total variable costs of a firm are the payments made to the variable inputs.

Opportunity costs are

the value of a resource in its next best use.

Opportunity costs

the value of a resource in its next best use; what an individual or firm must give up in order to do something

Opportunity costs

the value of a resource in its next-best use

Variable costs

those costs that vary with the level of output; the costs associated with the variable factors of production

Average total costs are

total costs divided by the level of output.

Average Costs/Average Total Costs

total costs per unit of output; [AC/ATC] = TC/Y; dollars/unit of output

Economic profits are

total revenue minus explicit and opportunity costs.

Accounting profits are

total revenue minus explicit costs.

In the long run, all factors are

variable and length depends on the situation

Average variable costs are

variable costs divided by the level of output.

Variable costs

vary with level of output, Increase with level of output because firms must purchase more resources to increase quantity of production