Economic CostsEqual to opportunity costsExplicit + implicit costsExplicit costs
Monetary paymentsImplicit costs
Value of next best useSelf-owned resourcesSelf-employed resources
8-2
Profit
Accounting profitTotal revenue less explicit cost
Normal profitEqual to implicit cost
Economic or pure profitTotal revenue less economic cost
8-3
Profits Compared
EconomicProfit
AccountingCosts (Explicit
Costs Only)
AccountingProfit
ExplicitCosts
Implicit Costs(Including
Normal Profit)
Eco
no
mic
(Op
po
rtu
nit
y)C
ost
s
To
tal
Rev
enu
e
Economic Accounting
8-4
Short and Long Run
The short runFixed plant capacityVariable intensity of plant useVariable output
The long run Variable plant capacityFirms enter and exit
8-5
Production Relationships
Total product (TP) Marginal product (MP) Average product (AP)
Average Product Total Product
Units of Labor=
Marginal ProductChange in Total Product
Change in Labor Input=
8-6
Law of Diminishing Returns
Fixed technologyAdd variable resource to fixed resource
Marginal product will declineBeyond some point
Rationale
8-7
IncreasingMarginalReturns
Law of Diminishing Returns
(1)Units of the
Variable Resource(Labor)
(2)Total Product
(TP)
(3)Marginal Product
(MP),Change in (2)/Change in (1)
(3)AverageProduct
(AP),(2)/(1)
012345678
01025456070757570
1015201510
50
-5
-10.0012.5015.0015.0014.0012.5010.71 8.75
]]]]]]]]
DiminishingMarginalReturns
NegativeMarginalReturns
8-8
0
10
20
30
To
tal P
rod
uct
, TP
1 2 3 4 5 6 7 8 9
20
10
Mar
gin
al P
rod
uct
, MP
1 2 3 4 5 6 7 8 9
TP
MP
AP
IncreasingMarginalReturns
DiminishingMarginalReturns
NegativeMarginalReturns
Law of Diminishing Returns
8-9
Short-Run Production Costs
Fixed CostsDo not vary with output
Variable CostsMaterials, most labor
Total CostTC = TFC + TVC
8-10
Per-Unit Production Costs
Average fixed cost AFC = TFC/Q
Average variable costAVC = TVC/Q
Average total cost ATC = TC/Q = TFC/Q + TVC/QATC = AFC+AVC
Marginal costMC = change in TC/change in Q 8-11
Short-Run Production Costs
Co
sts
1 2 3 4 5 6 7 8 9 100 Q
100
200
300
400
500
600
700
800
900
1000
$1100
TFC
TC
TVC
TotalCost
VariableCost
FixedCost
8-12
Short-Run Production Costs
Co
sts
1 2 3 4 5 6 7 8 9 100 Q
50
100
150
$200
AFC
MC
ATCAVC
AVC
AFC
8-13
Production RelationshipsMarginal cost and diminishing returnsMarginal cost and marginal productMarginal cost and average variable cost
Marginal cost and average total costProduction curves and cost curvesShifts in cost curves
8-14
Ave
rag
e P
rod
uct
an
dM
arg
inal
Pro
du
ctC
ost
(D
olla
rs)
Graphical Relationships
MPAP
MCAVC
Quantity of Output
Quantity of Labor
Production Curves
Cost Curves
8-15
Long-Run Production Costs
Choose your plant sizeMinimize ATCDifferent ATC curves
Short runLong run ATC
Envelope of short run ATC
8-16
Long-Run ATC Curve
Ave
rag
e T
ota
l C
ost
sATC-1
ATC-2
ATC-3 ATC-4
ATC-5
Output
Any number of short-run optimum size cost curves can be constructed
8-17
Long-Run ATC Curve
Long-RunATC
Ave
rag
e T
ota
l C
ost
sATC-1
ATC-2
ATC-3 ATC-4
ATC-5
Output
The long-run ATC curve just“envelopes” the short run ATCs
8-18
Long Run Production Cost
Economies of ScaleLabor specializationManagerial specializationEfficient capital
Diseconomies of ScaleConstant Returns to Scale
8-19
Long-Run ATC Shapes
Output
Long-run ATC curve where economiesof scale exist
Ave
rag
e T
ota
l C
ost
s
Long-RunATC
EconomiesOf Scale
Constant ReturnsTo Scale
DiseconomiesOf Scale
q1 q2
8-20
Output
Long-run ATC curve where costs arelowest only when large numbers areparticipating
Ave
rag
e T
ota
l C
ost
sEconomies
Of ScaleDiseconomies
Of Scale
Long-RunATC
Long-Run ATC Shapes
8-21