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Chapter 5 Costs and Production
Chapter 5 Costs and Production
Cost &
Production
Reading:
Sloman and
Garratt,
chapter 5
Prepared by:
Dr. Bawani
ECN1014 Lelchumanan &
Dr. Chong Poh
INTRODUCTORY Ling (DEF, SBS)
ECONOMICS
LEARNING
OBJECTIVES (LO)
After this lecture, you should be able to:
Describe the cost concepts
Explain short-run costs and long run costs
Explain the relationship between cost and production
Distinguish between economies of scale and diseconomies of scale
Concept of revenue
Identify how profit is determined and maximized.
Cost Concepts
Cost of production: expenses incurred by the producer in
producing a particular quantity of output.
Economists think of cost differently from financial accountants.
Accountants - retrospective view of firm’s finances and
operation.
Economists - forward-looking view; concerning with the
allocation of scarce resources (including opportunity cost)
3
Cost Concepts
Example:
A firm owns its own building and pays no rent for office space.
Does this mean the cost of office space is zero?
Accountant: Yes.
Economist: No. the building could have been rented instead.
Foregone rent is the opportunity cost of using the building for
production and should be included in economic costs of doing
business.
4
Implicit cost and Explicit cost
Implicit Cost: the value of input services that are used in production
which are not purchased in the market.
Example: the opportunity cost of owner’s wife providing (labor)
service in production, self- owned factory.
5
Cost Concept
Economic Cost = Implicit cost + Explicit cost
Accounting Cost = Explicit Cost
6
Cost Curves in the Short Run
Short Run: the period where at least one of the inputs must be
fixed.
7
Cost Curves in the Short Run
8
Cost Curves in the Short Run
3. Total Cost (TC) - sum of cost of all inputs, fixed and variable
inputs used to produce goods and services.
TC TFC TVC
9
Cost Curve in the Short Run
Total cost TC
Total Variable cost
is the vertical
Cost 400 increases with
sum of FC
($ per TVC Production. The shape
and VC.
year) is due to the law of
300 diminishing returns..
200
TFC Fixed cost does not
100
vary with output
50
0 1 2 3 4 5 6 7 8 9 10 11 12 13 Output
10
Cost Curve in the Short Run
4. Average Fixed Cost (AFC): the fixed cost per unit of output.
AFC is obtained by dividing the total fixed cost (TFC) by the total
output.
TFC
AFC
Q
11
Cost Curve in the Short Run
5. Average Variable Cost (AVC): the variable cost per unit of output.
AVC is obtained when TVC is divided by total output.
TVC
AVC
Q
12
Cost Curve in the Short Run
13
Cost Curve in the Short Run
7. Marginal Cost (MC) - change in the total cost that results from
producing another unit of output.
ΔVC ΔTC
MC
ΔQ ΔQ
14
Cost Curve in the Short Run
15
50
100 50 50 50 100
128 28 25 39 64
148 20 16.7 32.7 49.3
162 14 12.5 28 40.5
180 18 10 26 36
200 20 8.3 25 33.3
225 25 7.1 25 32.1
254 29 6.3 25.5 31.8
292 38 5.6 26.9 32.4
350 58 5 30 35
435 85 4.5 35 39.5
16
Cost Curve In The Long Run
In the long run, all inputs are variable inputs, there is no fixed
cost.
Long Run total cost (LRTC) - cost of producing goods and services
in the long run.
Long-run average cost curve (LRAC) - shows the minimum cost
of producing any given output when all the inputs are variable.
The LRAC curve is derived by a series of short- run average cost
curve (SAC). Tangent points of the SAC are joined and make up
the LRAC.
17
Cost Curve In The Long Run
When a firm has a plant
relating to SAC1 , total output
is Q1
If demand increase and the
firm wants to increase its
output from Q1 to Q2, the firm
can still operate on the same
plant to produce Q2. By
expanding the output in SAC2,
Q2 can produce at a lower
average point.
18
Cost Curve In The Long Run
Economies Of Scale - when inputs increase by
some percentage and output increases by a
greater percentage, causing unit costs to fall.
Constant Returns To Scale - when inputs
increased by some percentage and output
increases by an equal percentage, causing unit
costs to remain constant.
Diseconomies Of Scale - when inputs increase
by some percentage and output increases by a
smaller percentage, causing unit costs to rise.
19
Cost Curve In The Long Run
20
Cost Curve In The Long Run
21
Concept Of Revenue
1. Total Revenue (TR): the value of a firm’s sales. Ttotal amount
of money that a firm can obtain from the sales of its product.
TR=P x Q
22
PROFIT
MAXIMISATIO
N
Finding the profit-maximising output
profit maximised where MR = MC
FINDING THE PROFIT-MAXIMISING
OUTPUT USING MARGINAL CURVES
16
12
Costs and revenue (£)
0
1 2 3 4 5 6 7
Quantity
-4
MR
FINDING THE PROFIT-MAXIMISING
OUTPUT USING MARGINAL CURVES
MC
16
12
Costs and revenue (£)
4 e Profit-maximising
output
0
1 2 3 4 5 6 7
Quantity
-4
MR
PROFIT
MAXIMISATION
12 AC
Costs and revenue (£)
8
AR = 6
AC = 42/3 TOTAL PROFIT
4
AR
0
1 2 3 4 5 6 7
Quantity
-4 MR