What you give up for taking some action

Economics: The Cost Of Production

A firm's total costs can be divided between fixed costs and variable costs. Fixed costs are costs that do not change when the firm alters the quantity of output produced. Variable costs are costs that change when the firm alters the quantity of out- put produced.

From a firm's total cost, two related'measures of cost are derived. Average total cost is total cost divided by the quantity of output. Marginal cost is the amount by which total cost rises if output increases J?y 1 unit.

When analyzing firm behavior, it is often useful to graph average total cost and marginal cost. For

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CHAPTER 13 THE COSTS OF PRODUCTION 275

a typical firm, marginal cost rises with the quan- tity of output. Average total cost first falls as out- put increases and then rises as output increases further. The marginal-cost curve always crosses the average~total-cost curve at the minimum of average total cost. ·

A firm's costs often depend on the time horizon considered. In particular, many costs are fixed in the short run but variable in the long run. As a result, when the firm changes its level of produc- tion, average total cost may rise more in the short run than in the long run.

total revenue, p. 260 total cost, p. 260 profit, p. 260

production function, p. 263 marginal product, p. 264 diminishing marginal

average fixed cost, p. 268 average variable cost, p. 268 marginalcostp.268

product, p. 265 explicit costs, p. 261 implicit costs, p. 261 economic profit, p. 262 accounting profit, p. 262

fixed costs, p. 266 variable costs, p. 266 average total cost, p. 267

efficient scale, p. 270 economies of scale, p. 272 diseconomies of scale, p. 272 constant returns to scale, p. 273

1. What is the relationship between a firm's total revenue, profit, and total cost?

2. Give an example of an opportunity cost that an accountant might not count as a cost. Why would the accountant ignore. this cost?

3. What is marginal product, and what does it mean if it is diminishing?

4. Draw a production function that exhibits diminishing marginal product of labor. Draw the associated total-cost curve. (In both cases, be sure to label the axes.) Explain the shapes of the two curves you have drawn.

1. This chapter discusses many types of costs: opportunity cost, total cost, fixed cost, variable cost, average total cost, and marginal cost. Fill in the type of cost that best completes each sentence: a. What you give up for taking some action is

called the __ _ b. __ is falling when marginal cost is below

it and rising when marginal cost is above it.

5. Define total cost, average total cost, and marginal cost. How are they related?

6. Draw the marginal-cost and average-total-cost curves for a typical firm. Explain why the curves have the shapes that they do and why they cross where they do.

7. How and why does a firm's average-total-cost curve differ in the short run and in the long run?

8. Define economies of scale and explain why they might arise. Define diseconomies of scale and explain why they might arise.

c. A cost that does not depend on the quantity produced is a(n) ___ .

d. In the ice-cream industry in the short run, ___ includes the cost of cream and sugar but not the cost of the factory.

e. Profits equal total revenue less __ _ f. The cost of producing an extra unit of output

is the __ _

PARTY FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

2. Your aunt is thinking about opening a hardware store. She estimates that it would cost $500,000 per year to rent the location and buy the stock. In addition, she would have to quit her $50,000 per year job as an accountant. a. Define opportunity cost. b. What is your aunt's opportunity cost of

running a hardware store for a year? If your aunt thought she could sell $510,000 worth of merchandise in a year, should she open the store? Explain.

3. A commercial fisherman notices the following relationship between hours spent fishing and the quantity of fish caught:

Hours

0 hours 1 2 3 4 5

Quantity of Fish (in pounds)

0 lb. 10 18 24 28 30

a. What is the marginal product of each hour spent fishing? ·

b. Use these data to graph the fisherman's production function. Explain its shape.

c. The fisherman has a fixed cost of $10 (his pole). The opportunity cost of his time is $5 per hour. Graph the fisherman's total-cost curve. Explain its shape.

4. Nimbus, Inc., makes brooms and then sells them door-to-door. Here is the relationship between the number of workers and Nimbus's output in a given day:

Average Marginal Total Total Marginal

Workers Output Product Cost Cost Cost

0 0

20

2 50

3 90

4 120

5 140

6 150

7 155

a. Fill in the column of marginal products. Whaf pattern do you see? How might you explain it?

b. A worker costs $100 a day, and the firm has fixed costs of $200. Use this information to fill in the column for total cost.

c. Fill in the column for average total cost. (Recall that ATC = TC/Q.) What pattern do you see?

d. Now fill in the column for marginal cost. (Recall that MC = 11TC/ 11Q.) What pattern you see?

e. Compare the column for marginal product ·and the column for marginal cost. Explain the relationship.

f. Compare the column for average total cost and the column for marginal cost. Explain the relationship.

5. You are the chief financial officer for a firm that sells digital music players. Your firm has the following average-total-cost schedule:

Quantity

600 players 601

Average Total Cost

$300 301

Your current level of production is 600 devices, all 9f which have been sold. Someone calls, desperate to buy one of your music players. The caller offers you $550 for it. Should you accept the offer? Why or why not?

6. Consider the following cost information for a pizzeria:

Quantity Total Cost Variable Cost

0 dozen pizzas $300 $ 0 1 350 50 2 390 90 3 420 120 4 450 150 5 490 190 6 540 240

a. What is the pizzeria's fixed cost? b. Construct a table in which you calculate

the marginal cost per dozen pizzas using the information on total cost. Also, calculate the marginal cost per dozen pizzas using the information on variable cost. What is the relationship between these sets of numbers? Comment.