COST OF PRODUCTION

ECON 11– BASIC MICROECONOMICS

College of Business Administration

DR. PHILIP M. ALMANON

Program Coordinator - BSBA
pmalmanon@uv.edu.ph
09551136445
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

Objectives

• Describe and explain the concept of diminishing

marginal product.

• Describe and explain the short-run costs of the firm and

how they vary with the output levels that are produced.

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B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

COST OF PRODUCTION

Cost of production refers to the total sum of money needed

for the production of a particular quantity of output. As
defined by Gulhrie and Wallace, “In Economics, cost of
production features a special meaning. It is all about the
payments or expenditures essential to get the factors of
production of land, labor, capital and management needed
to produce a commodity.

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EXPLICIT COSTS, IMPLICIT COSTS, AND ECONOMIC PROFIT

Explicit costs are the actual, out-of –the pocket

expenditures of the firm to purchase or hire the services of
the factors of production it needs. Implicit cost are the
costs of the factors owned by the firm and used in its own
production processes. The costs should be imputed or
estimated from what these factors could earn in their best
alternative use or employment. In economics, costs include
both explicit and implicit costs. Profit is the excess of
revenues over these costs

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COLLEGE OF BUSINESS ADMINISTRATION
Price
B-ECONelasticity
1 –ofMICROECONOMICS
demand (PED) measures THOERY
the responsiveness of demand after a change in price.
AND PRACTICE

THE LAW OF DIMINISHING RETURNS

The law of diminishing returns is one of the most important
and unchallenged laws of production. This law states that as
we use more and more units of some factors of production
to work with one or more fixed factors, after a point we get
less and less extra or marginal output or product from each
additional unit of the variable factors used. The time period
when at least one factor of production is fixed in quantity
(i.e., cannot be varied) is referred to as the short-run. The
law of diminishing returns is a short-run law. In the long
run, all factors are variable.

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COLLEGE OF BUSINESS ADMINISTRATION
Price
B-ECONelasticity
1 –ofMICROECONOMICS
demand (PED) measures THOERY
the responsiveness of demand after a change in price.
AND PRACTICE

THE LAW OF DIMINISHING RETURNS

Example: Table below shows the total and

marginal product using each additional
unit of labor on the (say, one acre of) land.
Note that with zero labor, TP = 0. By
adding the first unit of labor, TP = 3 and
MP (i.e., the change in TP) = 3. By adding
the second unit of labor, TP = 8 and MP =
5. The third unit of labor leads to a TP of
12 and an MP of 4, etc. The law of
diminishing returns begins to operate in
this example with the additional of the
third unit of labor.

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COLLEGE OF BUSINESS ADMINISTRATION
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

SHORT-RUN TOTAL COSTS

In the short run, there are fixed costs, total variable costs, and total costs.

TOTAL FIXED COSTS (TFC) are the costs which the firm incurs in the short run for
its fixed inputs; these are constant regardless of the level of output and of
whatever it produces or not.

TOTAL VARIABLE COSTS (TVC) are costs incurred by the firm for the variable inputs
it uses. These vary directly with the level of output produced.

TOTAL COST are the equal sum of total fixed costs and total variable costs.

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COLLEGE OF BUSINESS ADMINISTRATION
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

SHORT-RUN TOTAL COSTS

Output Fixed Cost Variable Total Cost

Cost
Q FC VC C
0 50 0 50
1 50 40 90
2 50 70 120
3 50 90 140
4 50 100 150
5 50 120 170
6 50 150 200
7 50 190 240
8 50 240 290
9 50 300 350
10 50 370 420

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COLLEGE OF BUSINESS ADMINISTRATION
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

SHORT-RUN PER UNIT COSTS

Though total costs are very important, per unit or average costs are even more
important in the short-run analysis of the firm. The short-run per unit costs
that we consider are the Average Fixed Cost, The Average Variable Cost, The
Average Cost, and the Marginal Cost.

AVERAGE FIXED COST (AFC) equals total fixed costs divided by output.

AVERAGE VARIABLE COST (AVC) equals total variable costs divided by output

AVERAGE COST (AC) total costs divided by output or AFC + AVC

MARGINAL COSTS (MC) equals the change in TC or Change in TVC per unit
change in output

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COLLEGE OF BUSINESS ADMINISTRATION
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

SHORT-RUN PER UNIT COSTS

Output Output
Fixed Cost Fixed Cost
Variable Variable
TotalTotal
CostCost Marginal
Marginal Cost
Average Average
Average Fixed Average
Average Average Cost
Cost Cost Cost Fixed Variable Cost
Cost Variable Cost
Cost Cost
Q FC Q VC
FC VC
C C MC
MC AFC
AFCAVC AC
AVC AC
0 50 0 500 0 50 50 – – – – – – – –
1 50 1 5040 40 90 90 4040 50.0 50.040.0 40.0
90.0 90.0
2 50 2 5070 70 120120 3030 25.0 25.035.0 60.0
35.0 60.0
3 50 90 140 20 16.7 30.0 46.7
3 50 90 140 20 16.7 30.0 46.7
4 50 100 150 10 12.5 25.0 37.5
4 50 5 100
50 120
150170 20
10 10.0
12.524.0 34.0
25.0 37.5
5 50 6 120
50 150 170200 3020 8.3 10.025.0 24.0
33.3 34.0
6 50 7 150
50 190 200240 4030 7.1 8.327.1 25.0
34.3 33.3
7 50 8 50
190 240 240290 5040 6.3 7.130.0 36.3
27.1 34.3
9 50 300 350 60 5.6 33.3 38.9
8 50 240 290 50 6.3 30.0 36.3
10 50 370 420 70 5.0 37.0 42.0
9 50 300 350 60 5.6 33.3 38.9
10 50 370 420 70 5.0 37.0 42.0

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COLLEGE OF BUSINESS ADMINISTRATION
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

SHORT-RUN PER UNIT COSTS

Output Fixed Variable Total Cost Marginal Average Average Average

Cost Cost Cost Fixed Variable Cost
Cost Cost
Q FC VC C MC AFC AVC AC
0 50 0 50 – – – –
1 50 40 90 40 50.0 40.0 90.0
2 50 70 120 30 25.0 35.0 60.0
3 50 90 140 20 16.7 30.0 46.7
4 50 100 150 10 12.5 25.0 37.5
5 50 120 170 20 10.0 24.0 34.0
6 50 150 200 30 8.3 25.0 33.3
7 50 190 240 40 7.1 27.1 34.3
8 50 240 290 50 6.3 30.0 36.3
9 50 300 350 60 5.6 33.3 38.9
10 50 370 420 70 5.0 37.0 42.0

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COLLEGE OF BUSINESS ADMINISTRATION
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

LONG-RUN PRODUCTION COSTS

In the long run, there are no fixed factors and the firm
Output Fixed Variable Total Cost Marginal Average Average Average
Cost Cost Cost Fixed Variable Cost
can built a plant of any size. Once a firm has constructed Cost Cost
Q FC VC C MC AFC AVC AC
a particular plant, it operates in the short run. A plant
0 50 0 50 – – – –
1 50 40 90 40 50.0 40.0 90.0
size can be represented by its short run average cost
2
3
50
50
70
90
120
140
30
20
25.0
16.7
35.0
30.0
60.0
46.7

(SAC) curve. Larger plants can be represented by SAC

4
5
50
50
100
120
150
170
10
20
12.5
10.0
25.0
24.0
37.5
34.0

curves which lie further to the right. The long-run

6
7
50
50
150
190
200
240
30
40
8.3
7.1
25.0
27.1
33.3
34.3

average cost (LAC) curve shows the minimum per unit

8
9
50
50
240
300
290
350
50
60
6.3
5.6
30.0
33.3
36.3
38.9

cost of producing each level of output when any desired

10 50 370 420 70 5.0 37.0 42.0

size of plant can be built. The LAC curve is thus formed

from the relevant segment of the SAC curves.
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B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

LONG-RUN PRODUCTION COSTS

Output Fixed Variable Total Cost Marginal Average Average Average

Cost Cost Cost Fixed Variable Cost
Cost Cost
Q FC VC C MC AFC AVC AC
0 50 0 50 – – – –
1 50 40 90 40 50.0 40.0 90.0
2 50 70 120 30 25.0 35.0 60.0
3 50 90 140 20 16.7 30.0 46.7
4 50 100 150 10 12.5 25.0 37.5
5 50 120 170 20 10.0 24.0 34.0
6 50 150 200 30 8.3 25.0 33.3
7 50 190 240 40 7.1 27.1 34.3
8 50 240 290 50 6.3 30.0 36.3
9 50 300 350 60 5.6 33.3 38.9
10 50 370 420 70 5.0 37.0 42.0

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COLLEGE OF BUSINESS ADMINISTRATION
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CONSTANT, INCREASING, AND DECREASING RETURNS TO

SCALE

Three possible outcomes:

Output Fixed Variable Total Cost Marginal Average Average Average
Cost Cost Cost Fixed Variable Cost
1. Output increases in the same proportion, so that Cost Cost
Q FC VC C MC AFC AVC AC
there are constant returns to scale or constant cost
0 50 0 50 – – – –
1 50 40 90 40 50.0 40.0 90.0
2. Output increases by greater proportion, giving
2
3
50
50
70
90
120
140
30
20
25.0
16.7
35.0
30.0
60.0
46.7

increasing return to scale or decreasing costs

4
5
50
50
100
120
150
170
10
20
12.5
10.0
25.0
24.0
37.5
34.0

3. Output increases in a smaller proportion, giving

6
7
50
50
150
190
200
240
30
40
8.3
7.1
25.0
27.1
33.3
34.3

decreasing returns to scale or increasing cost.

8
9
50
50
240
300
290
350
50
60
6.3
5.6
30.0
33.3
36.3
38.9
10 50 370 420 70 5.0 37.0 42.0

UNIVERSITY OF THE VISAYAS

COLLEGE OF BUSINESS ADMINISTRATION
B-ECON 1 – MICROECONOMICS THOERY AND PRACTICE

https://slideplayer.com/slide/6320089/

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COLLEGE OF BUSINESS ADMINISTRATION