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The Costs & Production
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The Firms Objective
The economic goal of the firm is to
maximize profits.Profit is the firms total revenue minus its
total cost.
Profit = Total revenue - Total cost
Total Cost includes all of the opportunity costs of
production
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What happens to profit though as
you keep on adding workers?
Additional inputAdditional output=Marginal
product
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Diminishing Marginal Product
xDiminishing marginal product is the propertywhereby the
marginal product of an inputdeclines as the quantity of the
input
increases.xExample: As more and more workers are
hired at a firm, each additional workercontributes less and less
to production
because the firm has a limited amount ofequipment.
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A Production Function...
Quantity ofOutput
(cookiesper hour)
150
140
130120
110
100
90
80
70
6050
40
30
20
10
Number of Workers Hired0 1 2 3 4 5
Production function
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Fixed and Variable Costs
xFixed costs are those costs that do notvary with the quantity
of output produced.
xVariable costs are those costs that do
change as the firm alters the quantity ofoutput produced.
xShort Run vs. Long Run Costs
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Family of Total Costs
xTotal Fixed Costs (TFC)
xTotal Variable Costs (TVC)
xTotal Costs (TC)
TC = TFC + TVC
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Family of Total Costs
Quantity Total Cost Fixed Cost Variable Cost
0 $ 3.00 $3.00 $ 0.001 3.30 3.00 0.302 3.80 3.00 0.80
3 4.50 3.00 1.504 5.40 3.00 2.40
5 6.50 3.00 3.50
6 7.80 3.00 4.807 9.30 3.00 6.308 11.00 3.00 8.00
9 12.90 3.00 9.90
10 15.00 3.00 12.00
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Total-Cost Curve...
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
0 2 4 6 8 10 12
Quantity of Output
(glasses of lemonade per hour)
TotalC
ost
Total-costcurve
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Relation
Between
Production
Functionand Total
Cost.
Dimininishi
ng Returns
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Average Costs
xAverage costs can be determined by
dividing the firms costs by the
quantity of output produced.xThe average cost is the cost of
each
typical unit of product.
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Family of Average Costs
xAverage Fixed Costs (AFC)
xAverage Variable Costs (AVC)
xAverage Total Costs (ATC)
ATC = AFC + AVC
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Marginal Cost
xMarginal cost (MC) measures the
amount total cost rises when the firm
increases production by one unit.
xMarginal cost helps answer the
following question:x How much does it cost to produce an
additional unit of output?
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Marginal Cost
QTC=
quantity)in(Change
cost)totalin(Change=MC
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ATCAVC
MC
Average-Cost and Marginal-Cost
Curves...
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
0 2 4 6 8 10 12
Quantity of Output
(glasses of lemonade per hour)
Costs
AFC
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MC
ATC
Relationship Between Marginal Cost
and Average Total Cost
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
0 2 4 6 8 10 12
Quantity of Output
(glasses of lemonade per hour)
Costs
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Three Important Properties of Cost
Curves
xMarginal cost eventually rises with the
quantity of output.
x
Law of Diminishing Marginal ReturnsxThe average-total-cost curve
is U-shaped.
xThe marginal-cost curve crosses the
average-total-cost curve at the minimum of
average total cost.
xWork on homework assignment!
