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