Costs of Production - Manipal

N. Gregory Mankiw & Mohamed H.
Rashwan
Principles of
Economics Middle East Edition
Chapter 13
The Costs of Production
© 2012 Cengage Learning. EMEA All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
ACTIVE LEARNING 1
Brainstorming costs
You run a motor company in the UAE.

 List three different costs you have.
 List three different
business decisions
that are affected
by your costs.
© 2012 ©Cengage
2012 Cengage
Learning Learning.
EMEA. AllAll Rights
Rights Reserved.
Reserved. May
May not
not be
be copied,
copied, scanned,
scanned, or
or duplicated,
duplicated, in
in whole
whole or
or in
in part,
part, except
except for
for use as
2
use as permitted
permittedininaalicense
licensedistributed
distributedwith
withaacertain
certainproduct
productor
orservice
serviceor
orotherwise
otherwiseononaapassword-protected
password-protectedwebsite
websitefor
for classroom use.
Total Revenue, Total Cost, Profit
 We assume that the firm’s goal is to maximize
profit.
Profit = Total revenue (PxQ) –

Total cost
the amount a the market
firm receives value of the
from the sale inputs a firm
of its output uses in
production
© 2012 Cengage Learning EMEA. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
3
Costs: Explicit vs. Implicit
 Explicit costs require an outlay of money,
e.g., paying wages to workers.
 Implicit costs do not require a cash outlay,
e.g., the opportunity cost of the owner’s time.
 Remember one of the Ten Principles:
The cost of something is
what you give up to get it.
 This is true whether the costs are implicit or
explicit. Both matter for firms’ decisions.
4
Explicit vs. Implicit Costs: An Example
You need $100,000 to start your business.
The interest rate is 5%.
 Case 1: borrow $100,000
 explicit cost = $5000 interest on loan
 Case 2: use $40,000 of your savings,
borrow the other $60,000
 explicit cost = $3000 (5%) interest on the loan
 implicit cost = $2000 (5%) foregone interest you
could have earned on your $40,000.
In both cases, total (exp + imp) costs are $5000.

5
Economic Profit vs. Accounting Profit
 Accounting profit
= total revenue minus total explicit costs
 Economic profit
= total revenue minus total costs (including
explicit and implicit costs)
 Accounting profit ignores implicit costs,
so it’s higher than economic profit.
6
ACTIVE LEARNING 2
Economic profit vs. accounting profit
The equilibrium rent on office space has just

increased by $500/month.
Determine the effects on accounting profit and
economic profit if
a. you rent your office space
b. you own your office space
© 2012 ©Cengage
2012 Cengage
Learning Learning.
EMEA. AllAll Rights
Rights Reserved.
Reserved. May
May not
not be
be copied,
copied, scanned,
scanned, or
or duplicated,
duplicated, in
in whole
whole or
or in
in part,
part, except
except for
for use as
7
use as permitted
licensedistributed
distributedwith
withaacertain
certainproduct
productor
orservice
serviceor
orotherwise
websitefor
for classroom use.
ACTIVE LEARNING 2
Answers
The rent on office space increases $500/month.

a. You rent your office space.
Explicit costs increase $500/month.
Accounting profit & economic profit each fall
$500/month.
b.You own your office space.
Explicit costs do not change,
so accounting profit does not change.
Implicit costs increase $500/month (opp. cost
of using your space instead of renting it),
so economic profit falls by $500/month.
© 2012 ©Cengage
2012 Cengage
Learning Learning.
EMEA. AllAll Rights
Rights Reserved.
Reserved. May
May not
not be
be copied,
copied, scanned,
scanned, or
or duplicated,
duplicated, in
in whole
whole or
or in
in part,
part, except
except for
for use as
8
use as permitted
licensedistributed
distributedwith
withaacertain
certainproduct
productor
orservice
serviceor
orotherwise
websitefor
for classroom use.
EXAMPLE 1: Farmer’s Costs
 Farmer Mahmud must pay $1000 per month for
the land, regardless of how much wheat he
grows.
 The market wage for a farm worker is $2000 per
month.
 So Mahmud’s costs are related to how much
wheat he produces….
9
EXAMPLE 1: Farmer Mahmud’s Costs
L Q
Cost of Cost of Total
(no. of (bushels
land labor Cost
workers) of wheat)
0 0 $1,000 $0 $1,000
1 1000 $1,000 $2,000 $3,000
2 1800 $1,000 $4,000 $5,000
3 2400 $1,000 $6,000 $7,000

4 2800 $1,000 $8,000 $9,000
5 3000 $1,000 $10,000 $11,000
10
EXAMPLE 1: Farmer Mahmud’s Total Cost
Curve
Q
Total
(bushels
Cost
of wheat)
0 $1,000
1000 $3,000
1800 $5,000
2400 $7,000
2800 $9,000
3000 $11,000
11
Marginal Cost
 Marginal Cost (MC)
is the increase in Total Cost from
producing one more unit:
∆TC
MC =
∆Q
12
EXAMPLE 1: Total and Marginal Cost
Q
Total Marginal
(bushels
Cost Cost (MC)
of wheat)
0 $1,000
∆Q = 1000 ∆TC = $2000 $2.00
1000 $3,000
∆Q = 800 ∆TC = $2000 $2.50
1800 $5,000
∆Q = 600 ∆TC = $2000 $3.33
2400 $7,000
∆Q = 400 ∆TC = $2000 $5.00
2800 $9,000
∆Q = 200 ∆TC = $2000 $10.00
3000 $11,000
13
EXAMPLE 1: The Marginal Cost Curve
Q
(bushels TC MC MC usually rises
of wheat) as Q rises,
0 $1,000 as in this example.
$2.00
1000 $3,000
$2.50
1800 $5,000
$3.33
2400 $7,000
$5.00
2800 $9,000
$10.00
3000 $11,000
14
Why MC Is Important
 Mahmud is rational and wants to maximize
his profit. To increase profit, should he produce
more or less wheat?
 To find the answer, Mahmud needs to
“think at the margin.”
 If the cost of additional wheat (MC) is less than
the revenue he would get from selling it,
then the farmer’s profits rise if he produces more.
15
Fixed and Variable Costs
 Fixed costs (FC) do not vary with the quantity of
output produced.
 For Mahmud, FC = $1000 for his land
 Other examples:
cost of equipment, loan payments, rent
 Variable costs (VC) vary with the quantity
produced.
 For Mahmud, VC = wages he pays workers
 Other example: cost of materials
 Total cost (TC) = FC + VC
16
EXAMPLE 2
 Our second example is more general,
applies to any type of firm
producing any good with any types of inputs.
17
EXAMPLE 2: Costs
$800 FC
Q FC VC TC $700 VC
TC
0 $100 $0 $100 $600
1 100 70 170 $500
Costs
2 100 120 220 $400
3 100 160 260
$300
4 100 210 310
$200
5 100 280 380
$100
6 100 380 480
$0
7 100 520 620 0 1 2 3 4 5 6 7
Q
18
EXAMPLE 2: Marginal Cost
Q TC MC Recall, Marginal Cost (MC)

is the change in total cost from
0 $100
$70 producing one more unit:
1 170
50 ∆TC
2 220 MC =
∆Q
40
3 260 Usually, MC rises as Q rises, due
50 to diminishing marginal product.
4 310
70 Sometimes (as here), MC falls
5 380
100 before rising.
6 480
140 (In other examples, MC may be
7 620 constant.)
19
EXAMPLE 2: Average Fixed Cost
Q FC AFC Average fixed cost (AFC)

0 $100 n/a
is fixed cost divided by the
quantity of output:
1 100 $100
AFC = FC/Q
2 100 50
3 100 33.33
Notice that AFC falls as Q rises:
4 100 25 The firm is spreading its fixed
5 100 20 costs over a larger and larger
number of units.
6 100 16.67
7 100 14.29
20
EXAMPLE 2: Average Variable Cost
Q VC AVC Average variable cost (AVC)

is variable cost divided by the
0 $0 n/a
quantity of output:
1 70 $70
AVC = VC/Q
2 120 60
3 160 53.33 As Q rises, AVC may fall initially.
4 210 52.50 In most cases, AVC will
eventually rise as output rises.
5 280 56.00
6 380 63.33
7 520 74.29
21
EXAMPLE 2: Average Total Cost
Q TC ATC $200
Usually,
$175 as in this example,
0 $100 n/a
the ATC curve is U-shaped.
$150
1 170 $170
$125
Costs
2 220 110
$100
3 260 86.67
$75
4 310 77.50 $50
5 380 76 $25
6 480 80 $0
0 1 2 3 4 5 6 7
7 620 88.57
Q
22
EXAMPLE 2: Average Total Cost
Q TC ATC AFC AVC Average total cost

(ATC) equals total
0 $100 n/a n/a n/a
cost divided by the
1 170 $170 $100 $70 quantity of output:
2 220 110 50 60 ATC = TC/Q
3 260 86.67 33.33 53.33
Also,
4 310 77.50 25 52.50
ATC =TC/Q = FC/Q
5 380 76 20 56.00 + VC/Q = AFC + AVC
6 480 80 16.67 63.33
7 620 88.57 14.29 74.29
23
EXAMPLE 2: The Various Cost Curves Together
$200
$175
$150
ATC
$125
Costs
AVC
$100
AFC
MC $75
$50
$25
$0
0 1 2 3 4 5 6 7
Q
24
ACTIVE LEARNING 3
Calculating costs
Fill in the blank spaces of this table.

Q VC TC AFC AVC ATC MC
0 $50 n/a n/a n/a
$10
1 10 $10 $60.00
2 30 80
30
3 16.67 20 36.67
4 100 150 12.50 37.50
5 150 30
60
6 210 260 8.33 35 43.33
© 2012 ©Cengage
2012 Cengage
Learning Learning.
EMEA. AllAll Rights
Rights Reserved.
Reserved. May
May not
not be
be copied,
copied, scanned,
scanned, or
or duplicated,
duplicated, in
in whole
whole or
or in
in part,
part, except
except for
for use as
25
use as permitted
licensedistributed
distributedwith
withaacertain
certainproduct
productor
orservice
serviceor
orotherwise
websitefor
for classroom use.
ACTIVE LEARNING 3
Answers
Use AFC
ATC
AVC
deduce FC/Q
First,relationship
= TC/Q
VC/Q
FC between MC
= $50 and and
use FCTC
+ VC = TC.
Q VC TC AFC AVC ATC MC

0 $0 $50 n/a n/a n/a
$10
1 10 60 $50.00 $10 $60.00
20
2 30 80 25.00 15 40.00
30
3 60 110 16.67 20 36.67
40
4 100 150 12.50 25 37.50
50
5 150 200 10.00 30 40.00
60
6 210 260 8.33 35 43.33
© 2012 ©Cengage
2012 Cengage
Learning Learning.
EMEA. AllAll Rights
Rights Reserved.
Reserved. May
May not
not be
be copied,
copied, scanned,
scanned, or
or duplicated,
duplicated, in
in whole
whole or
or in
in part,
part, except
except for
for use as
26
use as permitted
licensedistributed
distributedwith
withaacertain
certainproduct
productor
orservice
serviceor
orotherwise
websitefor
for classroom use.
Costs in the Short Run & Long Run
 Short run:
Some inputs are fixed (e.g., factories, land).
The costs of these inputs are FC.
 Long run:
All inputs are variable
(e.g., firms can build more factories,
or sell existing ones).
27
29

Costs of Production - Manipal

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Costs of Production - Manipal

Uploaded by

Copyright:

Available Formats

N. Gregory Mankiw & Mohamed H.

You run a motor company in the UAE.

Profit = Total revenue (PxQ) –

In both cases, total (exp + imp) costs are $5000.

The equilibrium rent on office space has just

The rent on office space increases $500/month.

1 1000 $1,000 $2,000 $3,000

2 1800 $1,000 $4,000 $5,000

3 2400 $1,000 $6,000 $7,000

Q TC MC Recall, Marginal Cost (MC)

Q FC AFC Average fixed cost (AFC)

Q VC AVC Average variable cost (AVC)

Q TC ATC AFC AVC Average total cost

Fill in the blank spaces of this table.

Q VC TC AFC AVC ATC MC

You might also like