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The Costs Of
Production
Shaikha Salah AlMidfa 201017515Afra Humaid AlShamsi 20105205Fatima Obaid Al Suwaidi 201010455Fatma Ahmed AlFalasi 200911404
CONTENT
Total Revenue, Total Cost, and ProfitOpportunity CostsEconomic Profit vs. Accounting Profit Production & Costs
The Various Measures Of Costs
Costs In The Short & Long Run
Cost Of Production
Cost: “An amount that has to be paid or given up in order to get something.”
What controls the behavior of a producer?
(http://www.businessdictionary.com/definition/cost.html#ixzz1vKqC0lpM)
Industrial Organization
The study of how firms decisions about prices and quantities
depend on the market conditions they face. Examples on Market Conditions:
• Number of Competitors• What and how much a customer demands
Achieving profit
Profit = Total Revenue – Total Cost
Total Revenue: The amount a firm receives for the sale of its output
Total Cost: The market value of the inputs a firm uses in production
Opportunity Costs
“The cost of something is what you give up to get it”Ten Principles Of Economics
Explicit Costs: Input costs that require an outlay of money by the firm - Wages
- Rent Payments - Utilities
Implicit Costs: Input costs that do not require an outlay of money by the firm
Economists Vs. Accountants
Economists are interested in production & pricing decisions
Implicit Costs Explicit Costs
Accountants are interested in keeping track of money flows
Implicit Costs Explicit Costs
The Cost Of Capital Is An Opportunity Cost
The Opportunity Cost of the financial capital that has been invested in the business is an important implicit cost.
Capital: $ 900,000
$ 18,000(2%) Annual
> or < 18,000 ?Opportunity Cost
Economic & Accounting Profit
Economic Profit: Total revenue minus total cost (including both explicit & implicit costs)
Accounting Profit: Total revenue minus total explicit cost
* Accounting Profit > Economic profit Because Implicit costs are ignored.
Production function
Quantity of output (cookies
per hour)
Number of workers hired
0 3 42 51
20
40
60
80
100
Total cost curve
Total cost
Quantity of output
(cookies per hour)
020
40
60
80
120
100
10
403020
6050
Marginal product
Number of
workers
Output (quantity
of cookies
produced per hour)
Marginal products of labor
Cost of workers
Cost of
workers
Total cost of inputs cost of
factory + cost of
workers)
0 0 $30 $0 $30
1 50 30 10 40
2 90 30 20 50
3 120 30 30 60
4 140 30 40 70
5 150 30 50 80
Production function
5040302010
Diminishing marginal product
From the production function To The Total-Cost Curve
Fixed and variable costs
Fixed costs (FC): costs that do not vary with the quantity of output produced.
Variable costs (VC): costs that vary with the quantity of output produced.
Total cost (TC) = FC + VC
Example of the various measures of cost: Conrad’s coffee shop
Quantity of coffee (cups per hour)
Total cost
Fixed cost
Variable cost
Average fixed cost
Average variable cost
Average total cost
Marginalcost
0 $ 3.00 $ 3.00 $ 0.00 _ _ _
1 3.30 $ 3.00 0.30 $ 3.00 $ 0.30 $ 3.30 $ 0.30
2 3.80 $ 3.00 0.80 1.50 0.40 1.90 0.50
3 4.50 $ 3.00 1.50 1.00 0.50 1.50 0.70
4 5.40 $ 3.00 2.40 0.75 0.60 1.35 0.90
5 6.50 $ 3.00 3.50 0.60 0.70 1.30 1.10
6 7.80 $ 3.00 4.80 0.50 0.80 1.30 1.30
7 9.30 $ 3.00 6.30 0.43 0.90 1.33 1.50
8 11.00 $ 3.00 8.00 0.38 1.00 1.38 1.70
9 12.90 $ 3.00 9.90 0.33 1.10 1.43 1.90
10 15.00 $ 3.00 12.00 0.30 1.20 1.50 2.10
Conrad’s total-cost curve
Average and marginal cost
Average total cost = total cost/quantity
ATC = TC/Q
Marginal cost : the increase in total cost that arises from an extra unite of production.
Marginal cost = change in total cost/change in quantity
MC = ∆TC/ ∆Q
Cost curves and their shapes:
average total cost (ATC): total cost divided by the quantity of output.
Average fixed cost (AFC): fixed cost divided by the quantity of output.
Average variable cost (AVC): variable cost divided by the quantity of output.
Marginal cost (MC): the increase in total cost that arises from an extra unite of production.
Conrad’s average-cost and marginal-cost curves
The cost curves shown here for Conrad’s coffee shop have some features that are common to the cost curves of many firms in the economy.
1. Rising marginal cost
2. U-shaped average total cost
3. The relationship between marginal cost and average total cost.
Typical cost curves
The division of total costs
between fixed and variable
costs depends on the
time horizon.
Short Run
Example: Ford Motor Company
Size of the factory is fixed in the short run
To vary quantity of cars produced, ford will have to change the number of workers they employ.
Increase in quantity of cars produced, increases the cost.
Diminishing Marginal Returns:
“A law of economics stating that, as the number of new employees increases, the marginal product of an additional employee will at some point be less than the marginal product of the previous employee.”
Problem of overcrowding
Long Run
Example: Ford Motor Company
Inputs are variable in the long run
Firms can expand the size of factories, build new factories or close old ones.
Ford can expand both the size of the factory and the workforce
LRATC Curve
Firm can choose from 3 factory sizes: S, M, L.
The firm can change it’s factory size in the long run not in the short run.
LRATC Curve
To manufacture less than QA, in the long run the firm will choose size S.
To manufacture between QA and QB, in the long run the firm will choose size M.
To manufacture more than QB, in the long run the firm will choose size L.
Scale of Production
Economies of scale: Long run average total cost falls as the quantity of output increases.
Constant returns to scale: Long run average total cost stays the same as the quantity of output changes
Diseconomies of scale: Long run average total cost rises as the quantity of output increases
Scale of Production
Economies of Scale: Allows specialization among workers.
It allows each worker to become better at a specific task
Example: Assembly Line
Diseconomies of scale: Coordination problem
The more stretched the management become. It becomes less effective. QUIZ
Quick Quiz
1) Profit = Total Revenue + Total Cost
2) Accountants include Explicit & Implicit Costs
3) Fixed costs do not vary but variable costs do
True
False
False
Thanks For Listening