Costs

Lecture 5
Economic Analysis
of Costs
To maximize producers profit four calculation
should be considered;
1. Production
2. Cost of Production
3. Revenue
4. Profit
Chapter 10: Technology, Production, and Costs
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e. 2 of 47
Production (3 indicators)
10.2 LEARNING OBJECTIVE
The Short Run and the Long Run Distinguish between the economic
short run and the economic long run.
in Economics
Implicit Costs versus Explicit Costs
Opportunity cost The highest-

valued alternative that must be given
up to engage in an activity.
Explicit cost A cost that involves

spending money.
Implicit cost A nonmonetary

opportunity cost.
in Economics
The Difference between Fixed and Variable Costs
1. Total cost The cost of all the inputs a

firm uses in production.
2. Fixed costs Costs that remain constant as
output changes. (cost of capital X capital # )
3. Variable costs Costs that change as output

changes. (wage rate X labor #)
Total Cost = Fixed Cost + Variable Cost
TC = TFC + TVC
Making Distinguish between the economic
the Fixed Costs in the short run and the economic long run.
Publishing Industry
Connection
COST AMOUNT
Salaries and benefits $437,500
Rent 75,000
Utilities 20,000
Supplies 6,000
Postage 4,000
Travel 8,000
Subscriptions, etc. 4,000

Miscellaneous 5,000
Total $559,500
Publishers consider the salaries of

editors to be a fixed cost.
in Economics
Implicit Costs versus Explicit Costs
Table 10-1
Jill Johnson’s Costs per Year
Pizza dough, tomato sauce, and other ingredients $20,000

Wages 48,000
Interest payments on loan to buy pizza ovens 10,000
Electricity 6,000
Lease payment for store 24,000
Foregone salary 30,000
Foregone interest 3,000
Economic depreciation 10,000
Total $151,000
The Relationship between Short-Run Explain and illustrate the
Production and Short-Run Cost relationship between marginal cost
and average total cost.
4. Marginal cost The change in a firm’s total cost from

producing one more unit of a good or service.
ΔTC
MC =
ΔQ
5. Average total cost or Average cost Total
cost divided by the quantity of output produced.
The Relationship between Short-Run Explain and illustrate the
Production and Short-Run Cost relationship between marginal cost
and average total cost.
Why Are the Marginal and Average

Cost Curves U Shaped?
FIGURE 10-4
Jill Johnson’s Marginal Cost and
Average Total Cost of Producing
Pizzas
We can use the information in

the table to calculate Jill’s
marginal cost and average

total cost of producing pizzas.
For the first two workers
hired, the marginal product of
labor is increasing. This
increase causes the marginal
cost of production to fall. For
the last four workers hired,
the marginal product of labor
is falling. This causes the
marginal cost of production to
increase.
Graphing Cost Curves Graph average total cost, average

variable cost, average fixed cost,
and marginal cost.
6. Average fixed cost Fixed cost divided

by the quantity of output produced.
7. Average variable cost Variable cost
divided by the quantity of output produced.
TC
Average total cost = ATC =
Q
FC
Average fixed cost = AFC =
Q
VC
Average variable cost = AVC =
Q
ATC = AFC + AVC
Graphing Cost Curves Graph average total cost, average

variable cost, average fixed cost,
and marginal cost.
FIGURE 10-5
Costs at Jill Johnson’s
Restaurant
Jill’s costs of making pizzas are shown in the table and plotted in the graph. Notice threse
important:
(1) As output increases, AFC gets smaller and smaller.
(2) As output increases, the difference between ATC and AVC decreases.
Conclusion
Table 10-4
A Summary of Definitions of Cost
SYMBOLS AND
TERM DEFINITION EQUATIONS
Total cost The cost of all the inputs used by a firm, or fixed
TC
cost plus variable cost
Fixed costs Costs that remain constant when a firm’s level of
FC
output changes
Variable costs Costs that change when the firm’s level of output
VC
changes
ΔTC
Marginal cost Increase in total cost resulting from producing MC =

another unit of output ΔQ
Average total cost Total cost divided by the quantity of output TC
produced ATC =
Q
Average fixed cost Fixed cost divided by the quantity of output FC
produced AFC =
Q
Average variable cost Variable cost divided by the quantity of output VC
produced AVC =
Q
Implicit cost A nonmonetary opportunity cost ―
Explicit cost A cost that involves spending money ―
Assignments
Relations between SR Cost Functions
Try it; fill the missing values
Calculating Costs
q FC VC TC MC AC AFC AVC
0 55 - - -
1 30
2 110
3 20
4 40
5 31
6 280
7 315
8 110 60 6.9 53.1

Costs

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Lecture 5

Implicit Costs versus Explicit Costs

Opportunity cost The highest-

Explicit cost A cost that involves

Implicit cost A nonmonetary

The Difference between Fixed and Variable Costs

1. Total cost The cost of all the inputs a

3. Variable costs Costs that change as output

Total Cost = Fixed Cost + Variable Cost

Subscriptions, etc. 4,000

Publishers consider the salaries of

Pizza dough, tomato sauce, and other ingredients $20,000

4. Marginal cost The change in a firm’s total cost from

cost divided by the quantity of output produced.

Why Are the Marginal and Average

We can use the information in

marginal cost and average

Graphing Cost Curves Graph average total cost, average

6. Average fixed cost Fixed cost divided

ATC = AFC + AVC

Graphing Cost Curves Graph average total cost, average

(1) As output increases, AFC gets smaller and smaller.

Marginal cost Increase in total cost resulting from producing MC =

Explicit cost A cost that involves spending money ―

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