Chapter 13 The Costs of Production

N.
GREGORY MANKIW
PRINCIPLES OF
ECONOMICS
Eight Edition
CHAPTER The Costs

13 of Production
PowerPoint Slides prepared by:
V. Andreea CHIRITESCU
Eastern Illinois University
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 1
management system for classroom use.
What are Costs?, Part 1
• Industrial organization
– The study of how firms’ decisions about
prices and quantities depend on the
market conditions they face
• Assumption
– The goal of a firm is to maximize profit
• Profit
– Total revenue minus total cost
• Total revenue, TR = P × Q
– Amount a firm receives for the sale of its
output
– Quantity of output the firm produces times
the price at which it sells its output
• Total cost, TC
– Market value of the inputs a firm uses in
production
• Costs as opportunity costs
– The cost of something is what you give up
to get it
• Firm’s cost of production
– Include all the opportunity costs of making
its output of goods and services
– Explicit costs
– Implicit costs
• Explicit costs
– Input costs that require an outlay of
money by the firm
• Implicit costs
– Input costs that do not require an outlay of
money by the firm
– Ignored by accountants
• Total costs
= Explicit costs + Implicit costs
• The cost of financial capital as an
opportunity cost
– Implicit cost
– Interest income not earned on financial
capital
• Owned as saving
• Invested in business
– Not shown as cost by an accountant
• Economic profit
– Total revenue minus total cost
• Total costs includes both explicit and implicit
costs
• Accounting profit
– Total revenue minus total explicit cost
– Usually larger than economic profit
Figure 1 Economists versus Accountants
Economists include all opportunity costs when analyzing a firm, whereas accountants measure
only explicit costs. Therefore, economic profit is smaller than accounting profit.
Production and Costs, Part 1
• Production function
– Relationship between
• Quantity of inputs used to make a good
• And the quantity of output of that good
– Gets flatter as production rises
• Marginal product
– Increase in output that arises from an
additional unit of input
– Slope of the production function
Table 1 A Production Function and Total Cost:
Caroline’s Cookie Factory
(1) (2) (3) (4) (5) (6)
Number of Output Marginal Cost of Cost of Total Cost of
Workers (quantity of Product of Factory Workers Inputs (cost
cookies Labor of factory
produced per plus cost of
hour) workers)
0 0 Empty cell $30 $0 $30
1 50 50 30 10 40
2 90 40 30 20 50
3 120 30 30 30 60
4 140 20 30 40 70
5 150 10 30 50 80
6 155 5 30 60 90
• Diminishing marginal product
– Marginal product of an input declines as
the quantity of the input increases
– Production function gets flatter as more
inputs are being used
– The slope of the production function
decreases
• Total-cost curve
– Relationship between quantity produced
and total costs
– Gets steeper as the amount produced
rises
• Diminishing marginal product
• Producing one additional unit of output
requires a lot of additional units of inputs: very
costly
Figure 2 Caroline’s Production Function and Total-Cost Curve
The production function in panel (a) shows the relationship between the number of workers hired and the quantity of output
produced. Here the number of workers hired (on the horizontal axis) is from column (1) in Table 1, and the quantity of output
produced (on the vertical axis) is from column (2). The production function gets flatter as the number of workers increases,
reflecting diminishing marginal product.
The total-cost curve in panel (b) shows the relationship between the quantity of output produced and total cost of production.
Here the quantity of output produced (on the horizontal axis) is from column (2) in Table 1, and the total cost (on the vertical axis)
is from column (6). The total-cost curve gets steeper as the quantity of output increases because of diminishing marginal
product.
The Various Measures of Cost, Part 1
• 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
= Fixed cost + Variable cost
• Average fixed cost, AFC

– Fixed cost divided by the quantity of
output
• Average variable cost, AVC
– Variable cost divided by the quantity of
output
Table 2 The Various Measures of Cost: Conrad’s Coffee Shop
(1) (2) (3) (4) (5) (6) (7) (8)
Output Total Fixed Cost Variable Average Average Average Marginal
(cups of Cost Cost Fixed Variable Total Cost
coffee per Cost Cost Cost
hour)
0 $3.00 $3.00 $0.00 Empty cell Empty cell Empty cell Empty cell
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
Figure 3 Conrad’s Total-Cost Curve
Here the quantity of output

produced (on the horizontal
axis) is from column (1) in
Table 2, and the total cost
(on the vertical axis) is
from column (2). As in
Figure 2, the total-cost
curve gets steeper as the
quantity of output
increases because of
diminishing marginal
product.
• Average total cost, ATC

– Total cost divided by the quantity of output
– Average total cost = Total cost / Quantity
– ATC = TC / Q
– Cost of a typical unit of output
• If total cost is divided evenly over all the units
produced
• Marginal cost, MC
– Increase in total cost arising from an extra
unit of production
– Marginal cost = Change in total cost /
Change in quantity
– MC = ΔTC / ΔQ
– Increase in total cost
• From producing an additional unit of output
• Rising marginal cost curve

– Because of diminishing marginal product
• U-shaped average total cost curve
– ATC = AVC + AFC
– AFC – always declines as output rises
– AVC – typically rises as output increases
• Because of diminishing marginal product
– The bottom of the U-shape
• At quantity that minimizes average total cost
• Efficient scale
– Quantity of output that minimizes ATC
• Relationship between MC and ATC
– When MC < ATC: average total cost is
falling
– When MC > ATC: average total cost is
rising
– The marginal-cost curve crosses the
average-total-cost curve at its minimum
Figure 4 Conrad’s Average-Cost and Marginal-Cost Curves
This figure shows the average total

cost (ATC), average fixed cost
(AFC), average variable cost (AVC),
and marginal cost (MC) for
Conrad’s Coffee Shop.
All of these curves are obtained by
graphing the data in Table 2. These
cost curves show three common
features:
(1) Marginal cost rises with the
quantity of output.
(2) The average-total-cost curve is
U-shaped.
(3) The marginal-cost curve
crosses the average-total-cost
curve at the minimum of
average total cost.
• Typical cost curves

– Marginal cost eventually rises with the
quantity of output
– Average-total-cost curve is U-shaped
– Marginal-cost curve crosses the average-
total-cost curve at the minimum of
average total cost
Figure 5 Cost Curves for a Typical Firm
Many firms
experience increasing
marginal product
before diminishing
marginal product. As a
result, they have cost
curves shaped like
those in this figure.
Notice that marginal
cost and average
variable cost fall for a
while before starting
to rise.
Costs in Short and Long Run, Part 1
• Many decisions
– Fixed in the short run
– Variable in the long run
• Firms – greater flexibility in the long-run
– Long-run cost curves
• Differ from short-run cost curves
• Much flatter than short-run cost curves
– Short-run cost curves
• Lie on or above the long-run cost curves
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved 25
learning management system for classroom use.
Figure 6 Average Total Cost in Short & Long Runs
Because fixed costs are variable in the long run, the average-total-cost curve in the short run
differs from the average-total-cost curve in the long run
• Economies of scale
– Long-run average total cost falls as the
quantity of output increases
– Increasing specialization among workers
• 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
– Increasing coordination problems
Table 3 The Many Types of Cost: A Summary
Term Definition Mathematical
Description
Explicit costs Costs that require an outlay of Empty cell
money by the firm
Implicit costs Costs that do not require an outlay Empty cell
of money by the firm
Fixed costs Costs that do not vary with the FC
quantity of output produced
Variable costs Costs that vary with the quantity of VC
output produced
Total cost The market value of all the inputs TC = FC + VC
that a firm uses in production
Average fixed cost Fixed cost divided by the quantity of AFC = FC / Q

output
Average variable cost Variable cost divided by the quantity AVC = VC / Q
of output
Average total cost Total cost divided by the quantity of ATC = TC / Q
output
Marginal cost The increase in total cost that arises MC = ΔTC / ΔQ
from an extra unit of production

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N.

CHAPTER The Costs

0 0 Empty cell $30 $0 $30

• Average fixed cost, AFC

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

Here the quantity of output

• Average total cost, ATC

• Rising marginal cost curve

This figure shows the average total

• Typical cost curves

Average fixed cost Fixed cost divided by the quantity of AFC = FC / Q

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