Module 7: Costs of Production

• In economics, firms are assumed to maximize profits
• Profits = Total Revenue - Total Costs

  • TR - the amount a firm receives for the sale of its output
  • TC - the market value of the inputs a firm uses in production
• Explicit Costs

  • Input costs that require an outlay of money by the firm
  • Ex: raw materials, wages

  Implicit Costs

  • Input costs that do not require an outlay of money by the firm
  • Ex: next best employment alternative
• Economic Profits

  • Take into account implicit costs
  • Economic Profits = Total Revenue

                                        Explicit Costs

                                        Implicit Costs

  Accounting Profits

  • Accounting Profits = Total Revenue

                                          Explicit Costs
• Production function

  • Shows the relationship between the quantity of inputs used to make a good and the quantity of that good
• Marginal Product

  • The increase in output from one additional unit of product
  • It is also the slop of the production function
• Law of Diminishing Marginal Product – the marginal product of an input declines as the quantity of the input increases
• Measure of Costs

  1. Fixed Costs

  • Costs that do no vary with the quantity of output produced
  • Ex: office/store rent, internet connection costs 

  1. Variable Costs

  • Costs that vary with the quantity of output produced
  • Ex: wages, raw materials
  • Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC)
• • Average Total Cost = TC / Q
  • Average Fixed Cost = FC / Q
  • Average Variable Cost = VC / Q
  • Marginal Cost = ∆TC / ∆Q
• Long-run

  • In the long run, there is no fixed cost
  • Fixed cost come from fixed inputs
  • Given enough time, all inputs can be changed