RMIT Classification: Trusted

Chapter 8
Business Costs
and Production

Copyright © 2021 by W. W. Norton & Company, Inc.

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2. Big Questions

1. How are profits and losses calculated?​

2. How much should a firm produce?​

3. What costs do firms consider in the short run and the long run?​

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3a. Business Cost and Production

Explicit Cost (Profit) vs. Implicit Cost (Profit)​

• Economic profit = total revenues – (explicit costs + implicit costs)​

• Diminishing Marginal Product​

Production Cost in Short Run​

Variable cost, fixed cost, average cost, marginal cost, total cost​

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3b. Business Cost and Production

Production Cost in Long Run​

• Average cost, marginal cost, total cost​

• Three types of scale​

1. Economies of scale​

2. Diseconomies of scale​

3. Constant returns to scale​

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4. Business Decision-Making

You’re a manager of a fast food restaurant. What operation decisions

do you need to make?​

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5. Calculating Profit and Loss

Profit is the difference between revenue and costs.​

Total revenue (TR):​

▪ What is total revenue?​

Total cost (TC):​

• What is total cost?

Profit (or loss) =​

• When does the firm earn a profit? A loss?​

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6a. Explicit and Implicit Costs

Explicit costs:​

• What are explicit costs?​

• What are some examples?​

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6b. Explicit and Implicit Costs

Implicit costs:​

• Opportunity costs of __________________​

• Opportunity costs of __________________​

• Opportunity costs of __________________

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7. Explicit and Implicit Cost Examples

Explicit Costs Implicit Costs

Labor of owner who works for the
The electricity bill company but does not draw a
salary​
The capital invested in
Advertising in the newspaper​
the business​
The use of the owner’s
Employee wages​ car, computer, or other personal
equipment to conduct business​
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8. Accounting versus Economic Profit

Accounting profit:​

• Accounting profit = ___________ − ___________.​

Economic profit:​

• Economic profit = ___________ − (___________ + ___________).​

• Economic profit = ___________ − ___________.​

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9. Rates of Return, Historically

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10. Accounting and Economic Profits

Item Cost Type Amount ($)
Revenues​ $8,000​
Workers’ wages​ Explicit​ $4,000​
Insurance and rent​ Explicit​ $2,500​
Food ingredients​ Explicit​ $1,000​
Accounting Profits
Opportunity cost
Implicit​ $300​
of owner’s time​
Opportunity cost
Implicit​ $400​
of owner’s capital​
Economic Profits
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11. Class Activity: Think-Pair-Share:

Accounting vs. Economic Profit
You read a story about a company, ACME Corporation, that
earned $100 million last year and is forecasting a profit of $150
million this year.
A friend points out that this is a 50 percent gain in profits and urges
you to invest now.
​Because you are not quite sure about this opportunity, you ask your
friend how big ACME is. Your friend enthusiastically tells you that
ACME is a very large company with assets of $10 billion.
• What should you tell your friend?​

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12. Practice What You Know—1

Which of the following is an example of an implicit cost?​

A. Wages paid to employees.​

B. Cost of food delivery.​

C. The opportunity cost of the owner’s time.​

D. Monthly insurance premiums.​

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13. How Much Should a Firm

Produce?

Two main ideas:​

• Describe the factors that determine output.​

• How do firms use inputs to maximize production?​

Concepts:​

• Output—

• Factors of production (inputs) —

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14. Production Function

Production function:​

• Describes what?​

Production at McDonald’s:​

• Assume that the size of the restaurant, capital, and so on is fixed.​

• What happens to output as the manager hires more workers?​

• Marginal product:​
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Number of Workers Total Output Marginal Product

(Number of Meals of Labor 15.
Served per Hour)

0​ 0​ Marginal
1​ 5​
Product
2​ 15​
3​ 30​ of Labor
4​ 42​
Table
5​ 52​
6​ 60​
7​ 65​
8​ 67​
9​ 63​
10 55
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16. Total and Marginal Product—1

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17. Diminishing Marginal Product

Diminishing marginal product:​

• Occurs when?​

Why does this happen?​

What does diminishing marginal product tell us about the firm’s labor

input decision?​

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18. Total and Marginal Product—2

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19. Practice What You Know—2

Total output with seven workers is Q = 70. Total output with eight

workers is Q = 82. What is the marginal product of the eighth worker?​

A. 12​

B. 10​

C. 82​

D. 8​

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20. Practice What You Know—3

Where does diminishing marginal product begin?​

Workers​ Total Product​

1. 12​
0​ 0​
2. 10​ 1​ 3​
2​ 8​
3. 82​
3​ 10​
4. 8​ 4​ 11​
5​ 9​

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21. What Costs Do Firms Consider in

the Short Run and the Long Run?

From production decisions to costs.​

Short run:​

• Period of production in which _________________________.​

Long run:​

• Period of production in which _________________________.

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22a. Costs in the Short Run

Variable costs (VC):​

• What are variable costs?

Fixed costs (FC):​

• What are fixed costs?

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22b. Costs in the Short Run

Total cost (TC):​

• What is total cost?

• TC =

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22c. Costs in the Short Run

Average total cost (ATC):​

• What is the average total cost?

• ATC =

Average variable cost (AVC):​

• What is the average variable cost?

• AVC =​
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22d. Costs in the Short Run

Average fixed cost (AFC):​

• What is the average fixed cost?​

• AFC =

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22e. Costs in the Short Run

Marginal cost (MC):​

• What is the marginal cost?

• Change in _______ cost divided by change in _________.

• MC =​

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ATC​
TC​ MC​
AVC​ AFC​ TC ÷ Q or​
Q TVC TFC TVC +
TFC​ TVC ÷ Q​ TFC ÷ Q​ AVC +
ΔTC÷ΔQ
22f.
AFC​

0​ $0.00​ $100.00​ $100.00​ Costs in

10​ 30.00​ 100.00​ 130.00​ $3.00​ $10.00​ $13.00​ $3.00​

20​ 50.00​ 100.00​ 150.00​ 2.50​ 5.00​ 7.50​ 2.00​

the Short
30​ 65.00​ 100.00​ 165.00​ 2.17​ 3.33​ 5.50​ 1.50​ Run
40​ 77.00​ 100.00​ 177.00​ 1.93​ 2.50​ 4.43​ 1.20​

50​ 87.00​ 100.00​ 187.00​ 1.74​ 2.00​ 3.74​ 1.00

60​ 100.00​ 100.00​ 200.00​ 1.67 1.67​ 3.34​ 1.30​

70​ 120.00​ 100.00​ 220.00​ 1.71​ 1.43​ 3.14 2.00​

80​ 160.00​ 100.00​ 260.00​ 2.00​ 1.25​ 3.25​ 4.00​

90​ 220.00​ 100.00​ 320.00​ 2.44​ 1.11​ 3.55​ 6.00​

100​ 300.00​ 100.00​ 400.00​ 3.00​ 1.00 4.00​ 8.00​

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23. The Total Cost Curves

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24. Average Cost Curves and

Marginal Cost—1

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25a. Margin and Average Relationship

Think about two examples:​

• class GPA and sports statistics.​

Suppose the class average grade on the economics exam is

85 percent.​
• Smarty McGenius joins the class and gets 100 percent on

the exam.​
• What happens to the class average?​

• Lazy Nostudyson joins the class and gets 34 percent on the exam.​

• What happens to the class average?​

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25d. Margin and Average

Relationship

Suppose LeBron James has a scoring average of 30 points per

game.​

• If he has a game in which he scores 45 points, his average will . . .

• If he has a game in which he scores 12 points, his average will . . .​

Once again:​

• The average follows the margin.​

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26. Average Cost Curves and

Marginal Cost—2

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27a. Class Activity: Think-Pair-Share:

Calculating Costs

Q TVC TFC TC AVC AFC ATC MC

0​ 720​ — — — —

1​ 7​

2​ 740​

3​ 15​

4​ 202​

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27b. Class Activity: Think-Pair-Share:

Calculating Costs

Q TVC TFC TC AVC AFC ATC MC

0​ 0​ 720​ 720​ — — — —

1​ 7​ 720​ 727​ 7​ 720​ 727​ 7​

2​ 20​ 720 740​ 10​ 360​ 370​ 13​

3​ 45​ 720 765​ 15​ 240​ 255​ 25​

4​ 88​ 720 808​ 22​ 180​ 202​ 43​

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28a. Practice What You Know—4

Assuming the existence of an efficient scale, the MC, ATC, and AVC

curves are​

A. vertical.​

B. horizontal.​

C. hill-shaped.​

D. U-shaped.​

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28b. Practice What You Know—5

Suppose the wage rate that a company pays its workers increases.

In terms of the cost equations, which of the following is true?​

A. TC will increase, but ATC will decrease.​

B. TVC will increase, but AVC will decrease.​

C. The MC curve will become hill-shaped.​

D. The TFC and AFC will not change.​

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29. Long-run costs

What other decisions can a firm make in the long run?​

Scale:​

Efficient scale:​

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30. Three Types of Scale

Economies of scale:​

Diseconomies of scale:​

Constant returns to scale:​

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31. Costs in the Long Run

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32. Conclusion

• Costs are defined in a number of ways, but marginal cost plays the

most crucial role in a firm’s cost structure.​

• By observing what happens to marginal cost, you can understand

changes in average cost and total cost. This is why economists

place so much emphasis on marginal costs.​

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