•
Total Revenue
– The amount a firm receives for the sale of its output.
•
Total Cost
– The market value of the inputs a firm uses in production.
•
Profit
is the firm’s total revenue minus its total cost.
Profit = Total revenue
PRODUCTION
• The Production Function
– The production functionshows the relationship between quantity of inputs used to make a good and the quantity of output of that good.
• Marginal Product
– The marginal productof any input is the increase in output that occurs from employing an additional unit of that input in production.
• Diminishing Marginal Product
– Diminishing marginal productstates that 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.
• Diminishing Marginal Product
Quantity of Output (cookies per hour) 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10
Number of Workers Hired
0 1 2 3 4 5
Production function
MEASURES OF COST
•
Costs of production may be divided into
fixed costs
and
variable costs
.
•
•
Fixed costs
Fixed costs
are costs that do
not
vary with the quantity of output produced.
•
•
Variable costs
Variable costs
are costs that
vary
with the quantity of output produced.
•
Total Costs
– Total Fixed Costs (
TFC
)
– Total Variable Costs (
TVC
)
– Total Costs (
TC
)
•
Average Costs
– Average costs can be determined by dividing the firm’s costs by the quantity of
output the firm produces. (TC / Q)
– The average cost is the cost of each typical unit of product.
•
Calculating Average Costs
– Average Fixed Costs (
AFC
) = TFC / Q
– Average Variable Costs (
AVC
) = TVC / Q
– Average Total Costs (
ATC
) = TC / Q
–
ATC
=
AFC
+
AVC
Marginal Cost
• Marginal Cost
– Marginal 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?
MC
TC
Q
=
(change in total cost)
=
(change in quantity)
Calculating Marginal Cost
MC =
(change in TC / change in Q)
Quantity
Total
Cost
Marginal
Cost
Quantity
Total
Cost
Marginal
Cost
0
$3.00
—
1
3.30
$0.30
6
$7.80
$1.30
2
3.80
0.50
7
9.30
1.50
3
4.50
0.70
8
11.00
1.70
4
5.40
0.90
9
12.90
1.90
• A typical average total-average total-costcost curve is U-shaped.
• At low levels of output average total cost is high because fixed cost is spread over very few units.
• Average total cost declines as output increases.
• Average total cost starts rising because average variable cost rises substantially.
• Relationship between Marginal Cost and Average Total Cost:
– Whenever 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 its minimum.
Costs $3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 Quantity of Output (glasses of lemonade per hour) 0 1 2 3 4 5 6 7 8 9 10
ATC MC
$18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
Quantity of Output (bagels per hour)
TC
4
2
6
8
10
12
14
2.00
Total
Cost
0
Quantity of Output (bagels per hour)
Costs
$3.00
2.50
2.00
1.50
1.00
0.50
0
2
4
6
8
10
12
14
MC
ATC
AVC
AFC
Properties of Cost Curves:
Marginal cost eventually rises with the quantity of output. The average-total-cost curve is U-shaped.
Quantity of
Cars per Day
0
Average
Total
Cost
1,200
$12,000
ATC
in short
run with
small factory
ATC
in short
run with
medium factory
ATC
in short
run with
large factory
ATC
in long run
Quantity of
Cars per Day
0
Average
Total
Cost
1,200
$12,000
1,000
10,000
Economies
of
scale
ATC
in short
run with
small factory
ATC
in short
run with
medium factory
ATC
in short
run with
large factory
ATC
in long run
Diseconomies
of
scale
Constant
returns to
scale
Economies of scalemeans long-run average total cost falls as output increases.
Diseconomies of scalemeans long-run average total cost rises as output increases.
Summary
• The goal of firms is to maximize profit, which equals total revenue minus total cost.
• A typical firm’s production function gets flatter as the quantity of input increases, displaying the law of diminishing marginal returns.
• A 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 outputB.ATC(or AC) = TC / Q
• Marginal cost is the amount by which total cost would rise if output were increased by one unit.
• The average-total-cost curve is typically U-shaped.
• The marginal-cost curve crosses the average-total-cost curve at its minimum.
