Chapter 4

Costs of Production

Prepared by Murray Davidson, Centennial College.

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Learning Objectives
 The concept of economic profit.
 Firms’ short run and long run costs.

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The lowest-cost process provides
productive efficiency.

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Economic Costs
Economic costs include:
 explicit costs, which are payments to
resource supplies outside a business
 implicit costs, which are what owners give

up by being involved in a business

Economic profit = total revenue - economic costs

(explicit and implicit)
Accounting profit = total revenue - explicit costs.
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EXAMPLE: Costs for Jelani’s gelato shop
Jelani owns a small gelato shop on campus. Jelani
pays $20,000 a year for raw materials, and
$12,000 in rent. Jelani can work at the local coffee
shop for $25,000 a year. Identify and calculate the
explicit and implicit costs.

Explicit costs: raw materials and rent

= $20,000 + $12,000 = $32,000
Implicit cost: what owners give up by being involved in a
business = $25,000
Total costs = $32,000 + $25,000 = $57,000

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Production in the Short Run
In the short run:
 some inputs (such as capital) are fixed
 other inputs (such as labour) are variable

Total, average and marginal product:

 average product, which is total product
divided by the number of workers
 marginal product, which is the extra total

product associated with an additional

worker
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The Law of Diminishing Returns
Short-run production is determined by
the law of diminishing marginal returns.
According to this law:
 the addition of more variable input causes
marginal product to fall after some point
 average product also falls after some point

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Total, Marginal
Total, Marginal, and
and Average
Figure 4.2, Page 95 and Figure 4.3, Page 97
Average
Products Products
FIGURE 4.3

Total Production Marginal and Average Production

Both charts show the three stages

of production
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Costs in the Short Run
Short-run costs include:
 fixed costs (costs of all fixed inputs)
 variable costs (costs of all variable inputs)
 total cost (fixed costs + variable costs)

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Marginal Cost
Marginal cost is the extra cost of
producing another unit of output.
= change in total cost divided by the change
in total product.
The marginal cost curve is shaped like a
“J” because of the law of diminishing
marginal returns.

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Marginal Cost
FIGURE 4.6

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Per-Unit Costs
Per-unit costs include:
 average fixed cost (fixed costs divided by
total product)
 average variable cost (variable costs

divided by total product)

 average cost
 either total cost divided by total product
 or average fixed cost + average variable

cost
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Short-Run Costs
FIGURE 4.5

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The Family of Short-Run Cost Curves
FIGURE 4.7

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Long Run and Returns to Scale
The quantity of all inputs can be changed
in the long run.
 Increasing returns to scale: the % change in
output > the % change in inputs.
 Constant returns to scale: the % change in

output = the % change in inputs.

 Decreasing returns to scale: the % change

in output < the % change in inputs.

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Costs in the Long Run
 Long-run average cost is the minimum
short-run average cost at every output.
 The long-run average cost curve is

saucer-shaped because of various

ranges of returns to scale.

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Costs in the Long Run
FIGURE 4.8

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