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Micro-economics, Cost of production explained
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COST of PRODUCTION
Price of a good which is determined by the sum of the costs of the resources that went
into making itCOST
REVENUE
PROFIT
OPPORTUNITY COSTThe value of most appealing
alternative that is not chosen is called opportunity cost
1. To work all day and make some money
2. To take the day off and go to a movie
Opportunities
Opportunity cost = Explicit cost + Implicit cost
Explicit CostInput cost that requires an
outlay of money
Implicit CostInput cost that DO NOT
requires an outlay of money
To open a computer software firm. Payments that must be made include
• computer hardware, • utilities, • supplies, • property and other taxes,• maintenance costs, • payments to wholesalers,• salaries of office support staff
EXAMPLE of EXPLICIT COST
If starts computer software firm in his own building
• Owner works 60 hours a week• Lease payment or rent he would
otherwise receive • Could earn if invested elsewhere• Salaries they could earn if employed
in another business
EXAMPLE of IMPLICIT COST
Various Costs & their Measurements
QuantityFixed cost
Variable cost
Total cost=F.C+V.C
Average fixed cost=FC/Q
Average variable cost=VC/Q
Average total cost=AFC+AVC
Marginal costChange in total cost/change in quantity
0 $3 $0.0 $3 --- --- ---
$0.31 3 0.3 3.3 $3.0 $0.30 $3.3
0.52 3 0.8 3.8 1.5 0.40 1.9
Fixed Cost Costs that do not vary with the quantity of output produced e.g. salaries or rents
Variable Cost Costs that do vary with the quantity of output produced e.g. raw materials and additional labors
Marginal Cost The increase in total cost that arises from an additional unit of production.
Average Cost How much does it cost to make a typical unit of production.
Explicit Cost + Implicit Cost
Only Explicit Cost
Economic profit is always less than the accounting profit
No. of workers/ quantity
Output quantity of cookies produced/hour
Marginal product
Fixed cost/ cost of factory
Variable cost/ cost of workers
Total cost of inputs= F.C+V.C
0 0$50
$30 $0 $30
1 5040
30 10 40
2 9030
30 20 50
3 12020
30 30 60
4 14010
30 40 70
5 1505
30 50 80
6 155 30 60 90
Production Function
The relationship between quantity of input and output
Maximum output that can be produced from any combination of inputs available in a given time period
Law of Diminishing Marginal ProductThe property where the marginal product of an
input declines as the quantity of the input increases
Comparison of TC and Production Function
Shapes of Cost Curves & their Relationships
• MC first decline then will go up, intersects AVC & ATC• AVC go down, but not as steeply as MC, then go up• AFC declines continuously• ATC initially declines as FC is spread over a larger number of units,
but will go up as marginal costs increase due to the law of diminishing returns
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