Cost & Product

• Total cost (TC)


  The sum of all costs incurred by a company in the process of producing a certain level of output
• Fixed costs (FC)


  Costs that do not change with the level of output. Fixed costs are the same at all levels of output (even when production equals zero)
• Fixed costs


  • Amortization
  • Insurance
  • Interest expense
  • Rent
• Variable costs (VC)


  Costs that change with the level of output (variable costs = 0 when production is zero)
• Variable costs


  • Wages
  • Utilities
  • Materials used in production
• Total cost (TC)


  TC = FC + VC
• Average fixed cost (AFC)

  TFC / Q
• Average variable cost (AVC)


  TVC / Q
• Average total cost (ATC)


  TC / Q
• Marginal cost (MC)


  Cost of an additional unit of output
• Average fixed cost decreases with the increase of output
• Marginal cost curve intersects the AVC and ATC at their minimum points
• Economies of scale


  Cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output decreasing with increasing scale
• Diseconomies of scale


  Factors that raise average cost as the size of the firm rises in the long run
• Constant returns to scale

  Average costs do not change as firm size changes
• Economies of scale sources

  • Specialization and division of labor
  • Indivisibilities of capital
  • Cheaper materials
  • Modern technology allows companies to automate production processes
  • Cheaper financial capital
  • Cheaper logistics costs per unit
• Diseconomies of scale sources

  • Increased cost of managing
  • Problems with coordination as firm size rises
  • Problems with communication and informational noise
  • Lack of motivation - workers can often feel more isolated and less appreciated in a larger business and so their loyalty and motivation may diminish
• Minimum efficient scale (MES)

  The lowest level of output at which ATC is minimized
• Cobb-Douglas production function


  A function that defines the total amount of output produced by a firm as a function of the levels of input usage by the firm
• Total (Physical) Product (TPP) function

  A short-run relationship between the amount of labour and the level of output, ceteris paribus
• Average physical product (APP)


  TPP / amount of input
• Marginal physical product (MPP)


  The ratio of the change in output (TPP) to the change in the quantity of labor (or other input) used
• The MPP is positive when an increase in labor results in an increase in output, and negative if output falls when additional labor is used
• The law of diminishing returns states that as the level of a variable input rises in a production process in which all other inputs are fixed, output ultimately increases by progressively smaller increments
• The addition of a larger amount of one factor of production inevitably yields decreased per-unit incremental returns