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Chapter 13

The Cost of
Production

In
In this
this chapter
chapter you
you will
will
Examine
Examine what
what items
items are
are included
included in
in aa
firms
firms costs
costs of
of production.
production.
Analyze
Analyze the
the link
link between
between aa firms
firms
production
production process
process and
and its
its total
total costs.
costs.
Learn
Learn the
the meaning
meaning of
of average
average total
total cost
cost
and
and marginal
marginal cost
cost and
and how
how they
they are
are
related.
related.
Consider
Consider the
the shape
shape of
of aa typical
typical firms
firms cost
cost
curves.
curves.
Examine
Examine the
the relationship
relationship between
between shortshortrun
run and
and long
long run
run costs.
costs.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 2

THE
THE COSTS
COSTS OF
OF PRODUCTION
PRODUCTION
Supply
Supply and
and demand
demand are
are the
the two
two
words
words that
that economists
economists use
use most
most
often.
often.
Supply
Supply and
and demand
demand are
are the
the forces
forces
that
that make
make market
market economies
economies work.
work.
Modern
Modern microeconomics
microeconomics is
is about
about
supply,
supply, demand,
demand, and
and market
market
equilibrium.
equilibrium.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 3

THE
THE COSTS
COSTS OF
OF PRODUCTION
PRODUCTION
According
According to
to the
the Law
Law of
of Supply:
Supply:
Firms
Firms are
are willing
willing to
to produce
produce and
and
sell
sell aa greater
greater quantity
quantity of
of aa good
good
when
when the
the price
price of
of the
the good
good is
is high.
high.
This
This results
results in
in aa supply
supply curve
curve that
that
slopes
slopes upward.
upward.
The
The Firms
Firms Objective
Objective
The
The economic
economic goal
goal of
of the
the firm
firm is
is to
to
maximize
maximize profits.
profits.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 4

Total
Total Revenue,
Revenue, Total
Total Costs,
Costs, and
and
Profit
Profit
Total
Total Revenue
Revenue
The
The amount
amount aa firm
firm receives
receives for
for the
the sale
sale
of
of its
its output.
output.
Total
Total Cost
Cost
The
The market
market value
value of
of the
the inputs
inputs aa firm
firm
uses
uses in
in production.
production.
Profit
Profit
The
The firms
firms total
total revenue
revenue minus
minus its
its total
total
cost.
cost.

Profit
Profit == Total
Total revenue
revenue -- Total
Total cost
cost

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 5

Cost
Cost as
as an
an Opportunity
Opportunity Cost
Cost
A
Afirms
firms cost
cost of
of production
production includes
includes all
all the
the
opportunity
opportunity costs
costs of
of making
making its
its output
output of
of
goods
goods and
and services.
services.
Explicit
Explicit and
and Implicit
Implicit Costs
Costs
A
Afirms
firms cost
cost of
of production
production include
include
explicit
explicit costs
costs and
and implicit
implicit costs.
costs.
Explicit
Explicit costs
costsare
areinput
input costs
costs that
that require
requireaa
direct
directoutlay
outlayof
of money
moneyby
bythe
the firm.
firm.
Implicit
Implicit costs
costsare
areinput
inputcosts
coststhat
that do
do not
not
require
requirean
an outlay
outlayof
of money
moneyby
bythe
thefirm.
firm.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 6

Cost
Cost as
as an
an Opportunity
Opportunity Cost
Cost

Example:
Example:
Helen
Helenuses
uses$300
$300000
000of
of her
hersavings
savingsto
tobuy
buyher
her
cookie
cookiefactory
factoryfrom
from the
the previous
previousowner.
owner.
IfIf she
shehad
had left
lefther
her money
moneyin
inaa savings
savings account
account
that
that pays
paysan
aninterest
interestat
ataarate
rateof
of 55percent,
percent,she
she
would
wouldhave
haveearned
earned $15
$15000
000aayear.
year.
Helen
Helenby
bybuying
buyingaa cookie
cookie factory
factoryhas
has foregone
foregone
$15
$15000
000aayear
year in
in interest
interest income.
income.
This
Thisforegone
foregone$15
$15000
000is
isan
animplicit
implicit opportunity
opportunity
cost
cost of
of Helens
Helensbusiness.
business.
The
Theaccountant
accountantwill
will not
notshow
show this
thiscost.
cost.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 7

Economic
Economic Profit
Profit versus
versus
Accounting
Accounting Profit
Profit
Economists
Economists measure
measure aa firms
firms
economic
economic profit
profit as
as total
total revenue
revenue
minus
minus total
total cost,
cost, including
including both
both
explicit
explicit and
and implicit
implicit costs.
costs.
Accountants
Accountants measure
measure the
the
accounting
accounting profit
profit as
as the
the firms
firms
total
total revenue
revenue minus
minus only
only the
the
firms
firms explicit
explicit costs.
costs.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 8

Economic
Economic Profit
Profit Versus
Versus
Accounting
Accounting Profit
Profit
When
When total
total revenue
revenue exceeds
exceeds both
both
explicit
explicit and
and implicit
implicit costs,
costs, the
the firm
firm
earns
earns economic
economic profit.
profit.
Economic
Economic profit
profit is
is smaller
smaller than
than
accounting
accounting profit.
profit.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 9

Figure
Figure 13-1:
13-1: Economists
Economists versus
versus
Accountants
Accountants
How an
Accountant
Views a Firm

How an
Economist
Views a Firm

Economic profit
Accounting
profit
Revenue

Implicit costs

Revenue
Total
Opportunity
Costs

Explicit costs

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Explicit costs

Chapter 13: Page 10

PRODUCTION
PRODUCTION AND
AND COSTS
COSTS
Assumption:
Assumption: The
The size
size of
of Helens
Helens
cookie
cookie factory
factory is
is fixed
fixed and
and the
the
quantity
quantity of
of cookies
cookies produced
produced
can
can only
only vary
vary by
by changing
changing the
the
number
number of
of workers.
workers.
This
This assumption
assumption is
is realistic
realistic in
in
the
the short-run
short-run but
but not
not the
the longlongrun.
run.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 11

Table
Table 13-1:
13-1: A
AProduction
Production Function
Function and
and Total
Total
Cost:
Cost: Hungry
Hungry Helens
Helens Cookie
Cookie Factory
Factory
Number of
workers

Output
(quantity of
cookies
produced per
hour)

Marginal
product of
labour

Cost of
factory

Cost of
worker

Total cost of
inputs (cost
of factory +
cost of
workers)

$30

$0

$30

30

10

40

30

20

50

30

30

60

30

40

70

30

50

80

50
1

50
40

90
30

120
20

140
10

150

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 12

PRODUCTION
PRODUCTION AND
AND COSTS
COSTS
The
TheProduction
ProductionFunction
Function
The
Theproduction
productionfunction
function shows
showsthe
the
relationship
relationship between
between quantity
quantityof
of inputs
inputsused
used to
to
make
makeaagood
goodand
and the
the quantity
quantityof
ofoutput
output of
of that
that
good.
good.
Marginal
Marginal Product
Product
The
Themarginal
marginal product
product of
of any
anyinput
input in
in the
the
production
productionprocess
processis
isthe
theincrease
increase in
inoutput
output
that
that arises
arisesfrom
from an
anadditional
additional unit
unitof
ofthat
that input.
input.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 13

PRODUCTION
PRODUCTION AND
AND COSTS
COSTS
Diminishing
Diminishing Marginal
Marginal Product
Product
Diminishing
Diminishing marginal
marginal product
product is
is the
the
property
property whereby
whereby the
the marginal
marginal product
product
of
of an
an input
input declines
declines as
as the
the quantity
quantity of
of
the
the input
input increases.
increases.
Example:
Example:As
As more
more and
and more
moreworkers
workers are
are
hired
hiredat
at aafirm,
firm,each
each additional
additional worker
worker
contributes
contributesless
lessand
and less
lessto
to production
production
because
becausethe
thefirm
firm has
has aalimited
limitedamount
amount of
of
equipment.
equipment.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 14

Figure
Figure 13-2:
13-2: Hungry
Hungry Helens
Helens Production
Production
Function
Function
Quantity of
Output
(cookies per
hour)

150
140

Production
function

120
90

50

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Number of Workers Hired

Chapter 13: Page 15

PRODUCTION
PRODUCTION AND
AND COSTS
COSTS
Diminishing
Diminishing Marginal
Marginal Product
Product
Diminishing
Diminishing marginal
marginal product
product is
is the
the
property
property whereby
whereby the
the marginal
marginal product
product
of
of an
an input
input declines
declines as
as the
the quantity
quantity of
of
the
the input
input increases.
increases.
Example:
Example:As
As more
more and
and more
moreworkers
workers are
are
hired
hiredat
at aafirm,
firm,each
each additional
additional worker
worker
contributes
contributesless
lessand
and less
lessto
to production
production
because
becausethe
thefirm
firm has
has aalimited
limitedamount
amount of
of
equipment.
equipment.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 16

PRODUCTION
PRODUCTION AND
AND COSTS
COSTS
Diminishing
Diminishing Marginal
Marginal Product
Product
The
The slope
slope of
of the
the production
production function
function
measures
measures the
the marginal
marginal product
product of
of an
an
input,
input, such
such as
as aa worker.
worker.
When
When the
the marginal
marginal product
product declines,
declines,
the
the production
production function
function becomes
becomes flatter.
flatter.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 17

From
From the
the Production
Production Function
Function to
to
the
the Total-Cost
Total-Cost Curve
Curve
The
The relationship
relationship between
between the
the quantity
quantity aa
firm
firm can
can produce
produce and
and its
its costs
costs determines
determines
pricing
pricing decisions.
decisions.
See
See last
last three
three columns
columns in
in Table
Table 13-1.
13-1.
The
The total-cost
total-cost curve
curve shows
shows this
this
relationship
relationship graphically.
graphically.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 18

Table
Table 13-1:
13-1: A
AProduction
Production Function
Function and
and Total
Total
Cost:
Cost: Hungry
Hungry Helens
Helens Cookie
Cookie Factory
Factory
Number of
workers

Output
(quantity of
cookies
produced per
hour)

Marginal
product of
labour

Cost of
factory

Cost of
worker

Total cost of
inputs (cost
of factory +
cost of
workers)

$30

$0

$30

30

10

40

30

20

50

30

30

60

30

40

70

30

50

80

50
1

50
40

90
30

120
20

140
10

150

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 19

Figure
Figure 13-3:
13-3: Hungry
Hungry Helens
Helens Total-Cost
Total-Cost
Curve
Curve
Total Cost

Total-cost curve
$80
70
60
50
40
30

50

90

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

140

120

150

Quantity of
Output
(cookies per
hour)
Chapter 13: Page 20

THE
THE VARIOUS
VARIOUS MEASURES
MEASURES OF
OF
COST
COST
Costs
Costs of
of production
production may
may be
be divided
divided
into
into fixed
fixed costs
costs and
and variable
variable costs.
costs.
Fixed
Fixed costs
costs are
are those
those costs
costs that
that do
do
not
not vary
vary with
with the
the quantity
quantity of
of output
output
produced.
produced.
Variable
Variable costs
costs are
are those
those costs
costs that
that
do
do vary
vary with
with the
the quantity
quantity of
of output
output
produced.
produced.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 21

THE
THE VARIOUS
VARIOUS MEASURES
MEASURES OF
OF
COST
COST
Total
Total Costs
Costs
Total
Total Fixed
Fixed Costs
Costs (TFC)
(TFC)
Total
Total Variable
Variable Costs
Costs (TVC)
(TVC)
Total
Total Costs
Costs (TC)
(TC)
TC
TC == TFC
TFC ++ TVC
TVC

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 22

THE
THE VARIOUS
VARIOUS MEASURES
MEASURES OF
OF
COST
COST
Average
Average Costs
Costs
Average
Average costs
costs can
can be
be determined
determined
by
by dividing
dividing the
the firms
firms costs
costs by
by the
the
quantity
quantity of
of output
output itit produces.
produces.
The
The average
average cost
cost is
is the
the cost
cost of
of
each
each typical
typical unit
unit of
of product.
product.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 23

THE
THE VARIOUS
VARIOUS MEASURES
MEASURES OF
OF
COST
COST
Average
Average Costs
Costs
Average
Average Fixed
Fixed Costs
Costs (AFC)
(AFC)
== ATC
ATC // Q
Q
Average
Average Variable
Variable Costs
Costs (AVC)
(AVC)
== AVC
AVC // Q
Q
Average
Average Total
Total Costs
Costs (ATC)
(ATC)
== ATC
ATC // Q
Q
ATC
ATC == AFC
AFC ++ AVC
AVC
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 24

THE
THE VARIOUS
VARIOUS MEASURES
MEASURES OF
OF
COST
COST
Marginal
Marginal Cost
Cost
Marginal
Marginal cost
cost (MC)
(MC) measures
measures the
the
increase
increase in
in total
total cost
cost that
that arises
arises
from
from an
an extra
extra unit
unit of
of production.
production.
Marginal
Marginal cost
cost helps
helps answer
answer the
the
following
following question:
question:
How
How much
much does
does itit cost
cost to
to produce
produce an
an
additional
additional unit
unit of
of output?
output?

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 25

THE
THE VARIOUS
VARIOUS MEASURES
MEASURES OF
OF
COST
COST
Marginal
Marginal Cost
Cost
Marginal
Marginal cost
cost (MC)
(MC) measures
measures the
the
increase
increase in
in total
total cost
cost that
that arises
arises from
from an
an
extra
extra unit
unit of
of production.
production.
Marginal
Marginal cost
cost helps
helps answer
answer the
the
following
following question:
question:
How
How much
much does
doesitit cost
costto
toproduce
producean
an
additional
additional unit
unit of
of output?
output?

( c h a n g e in to ta l c o s t) T C
M C

(c h a n g e in q u a n tity )
Q
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 26

Table
Table 13-2:
13-2: The
The Various
Various Measures
Measures of
of Cost:
Cost:
Thirsty
Thirsty Thelmas
Thelmas Lemonade
Lemonade Stand
Stand
Quantity
of
lemonade
Total Cost

Fixed
Cost

Variable
Cost

Average
Fixed
Cost

$ 3.00

$ 3.00

$ 0.00

---------

---------

---------

3.30

3.00

0.30

$ 3.00

$ 0.30

$ 3.30

3.80

3.00

0.80

1.50

0.40

1.90

4.50

3.00

1.50

1.00

0.50

1.50

5.40

3.00

2.40

0.75

0.60

1.35

6.50

3.00

3.50

0.60

0.70

1.30

7.80

3.00

4.80

0.50

0.80

1.30

9.30

3.00

6.30

0.43

0.90

1.33

11.00

3.00

8.00

0.38

1.00

1.38

12.90

3.00

9.90

0.33

1.10

1.43

10

15.00

3.00

12.00

0.30

1.20

1.50

(Glasses per
hour)

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Average
Variable
Cost

Average
Total Cost

Chapter 13: Page 27

Marginal
Cost

0.30
0.50
0.70
0.90
1.10
1.30
1.50
1.70
1.90
2.10

Figure
Figure 13-4:
13-4: Thirsty
Thirsty Thelmas
Thelmas Total-Cost
Total-Cost
Curve
Curve
Total Cost

Total-cost curve

15.00

11.00

5.40

3.00

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

10
Quantity of Output (glasses
of lemonade per hour)
Chapter 13: Page 28

Cost
Cost Curves
Curves and
and their
their Shapes
Shapes
The
The cost
cost curves
curves shown
shown here
here for
for Thirsty
Thirsty
Thelmas
Thelmas Lemonade
Lemonade Stand
Stand have
have some
some
features
features that
that are
are common
common to
to the
the cost
cost
curves
curves of
of many
many firms
firms in
in the
the economy.
economy.
Lets
Lets examine
examine three
three features
features in
in particular:
particular:
The
The shape
shape of
of the
the marginal
marginal cost
cost curve
curve
The
The shape
shape of
of the
the average
average cost
cost curve
curve
The
The relationship
relationship between
between marginal
marginal and
and
average
average total
total cost
cost

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 29

Figure
Figure 13-5:
13-5: Thirsty
Thirsty Thelmas
ThelmasAverage-Cost
Average-Cost
and
and Marginal-Cost
Marginal-Cost Curves
Curves
Costs
3.30
3.00

MC
ATC
AVC

1.30

AFC

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

10
Quantity of Output (glasses
of lemonade per hour)

Chapter 13: Page 30

Cost
Cost Curves
Curves and
and their
their Shapes
Shapes
Marginal
Marginal cost
cost rises
riseswith
withthe
theamount
amount of
of output
output
produced.
produced.
This
Thisreflects
reflectsthe
the property
propertyof
of diminishing
diminishing
marginal
marginalproduct.
product.
The
Theaverage
averagetotal-cost
total-cost curve
curve is
is U-shaped.
U-shaped.
At
At very
verylow
low levels
levelsof
ofoutput
output average
averagetotal
totalcost
cost is
is
high
high because
becausefixed
fixedcost
cost is
isspread
spreadover
overonly
onlyaafew
few
units.
units.
Average
Averagetotal
totalcost
cost declines
declinesas
as output
output increases.
increases.
Average
Averagetotal
totalcost
cost starts
startsrising
risingbecause
becauseaverage
average
variable
variablecost
costrises
risessubstantially.
substantially.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 31

Cost
Cost Curves
Curves and
and their
their Shapes
Shapes
The
Thebottom
bottomof
of the
the U-shaped
U-shaped ATC
ATCcurve
curveoccurs
occursat
at
the
thequantity
quantitythat
that minimizes
minimizesaverage
averagetotal
total cost.
cost.
This
Thisquantity
quantityis
issometimes
sometimescalled
calledthe
the efficient
efficient
scale
scale of
of the
thefirm.
firm.
Relationship
Relationshipbetween
between Marginal
Marginal Cost
Cost and
andAverage
Average
Total
Total Cost
Cost
Whenever
Whenevermarginal
marginal cost
costis
isless
lessthan
thanaverage
average
total
total cost,
cost, average
averagetotal
total cost
cost is
is falling.
falling.
Whenever
Whenevermarginal
marginal cost
costis
isgreater
greaterthan
than
average
averagetotal
totalcost,
cost, average
average total
total cost
cost is
is rising.
rising.
The
Themarginal-cost
marginal-cost curve
curvecrosses
crossesthe
theaverageaveragetotal-cost
total-costcurve
curveat
atthe
theefficient
efficient scale.
scale.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 32

Typical
Typical Cost
Cost Curves
Curves
In
In the
the previous
previous examples,
examples, the
the firms
firms
exhibit
exhibit diminishing
diminishing marginal
marginal product
product
and,
and, therefore,
therefore, rising
rising marginal
marginal cost
cost
at
at all
all levels
levels of
of output.
output.
Actual
Actual firms
firms are
are often
often aa bit
bit more
more
complicated
complicated than
than this.
this. E.g.,
E.g.,
diminishing
diminishing marginal
marginal product
product does
does
not
not start
start after
after the
the first
first worker
worker id
id
hired.
hired.
Table
Table 13-3
13-3 shows
shows such
such aa firm.
firm.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 33

Table
Table 13-3:
13-3: The
The Various
Various Measures
Measures of
of Cost:
Cost:
Big
Big Bobs
Bobs Bagel
Bagel Bin
Bin
Quantity
of lBagels

Variable
Cost

Average
Fixed
Cost

Average
Variable
Cost

Average
Total Cost

(per hour)

Total Cost

Fixed
Cost

$ 2.00

$ 2.00

$ 0.00

---------

---------

---------

3.00

2.00

1.00

$ 2.00

$ 1.00

$ 3.00

3.80

2.00

1.80

1.00

0.90

1.90

4.40

2.00

2.40

0.67

0.80

1.47

5.20

2.00

2.80

0.50

0.70

1.20

5.80

2.00

3.20

0.40

0.64

1.04

6.60

2.00

3.80

0.33

0.63

0.96

7.60

2.00

4.60

0.29

0.66

0.95

8.80

2.00

5.60

0.25

0.70

0.98

10.20

2.00

6.80

0.22

0.76

1.02

10

11.80

2.00

8.20

0.20

0.82

1.07

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 34

Marginal
Cost

1.00
0.80
0.60
0.40
0.40
0.60
0.80
1.00
1.20
1.40

Figure
Figure 13-6a):
13-6a): Big
Big Bobs
Bobs Cost
Cost Curves
Curves
(a) Total-Cost Curve
Total
Cost
TC

$18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0

10

12

14

Quantity of Output (bagels per hour)


Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 35

Copyright 2004 South-Western

Figure
Figure 13-6b):
13-6b): Big
Big Bobs
Bobs Cost
Cost Curves
Curves
(b) Marginal- and Average-Cost Curves
Costs
$3.00
2.50
MC
2.00
1.50

ATC
AVC

1.00
0.50

AFC
0

10

12

14

Quantity of Output (bagels per hour)


Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 36

Copyright 2004 South-Western

Typical
Typical Cost
Cost Curves
Curves
Three
Three Important
Important Properties
Properties of
of Cost
Cost
Curves
Curves
Marginal
Marginal cost
cost eventually
eventually rises
rises with
with
the
the quantity
quantity of
of output.
output.
The
The average-total-cost
average-total-cost curve
curve is
is UUshaped.
shaped.
The
The marginal-cost
marginal-cost curve
curve crosses
crosses
the
the average-total-cost
average-total-cost curve
curve at
at the
the
minimum
minimum of
of average
average total
total cost.
cost.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 37

THE
THE RELATIONSHIP
RELATIONSHIP BETWEEN
BETWEEN THE
THE
SHORT
SHORT RUN
RUN AND
AND THE
THE LONG
LONG RUN
RUN
For
For many
many firms,
firms, the
the division
division of
of total
total costs
costs
between
between fixed
fixed and
and variable
variable costs
costs depends
depends
on
on the
the time
time horizon
horizon being
being considered.
considered.
In
In the
the short
short run,
run, some
some costs
costs are
are fixed.
fixed.
In
In the
the long
long run,
run, fixed
fixed costs
costs become
become
variable
variable costs.
costs.
Because
Because many
many costs
costs are
are fixed
fixed in
in the
the short
short
run
run but
but variable
variable in
in the
the long
long run,
run, aa firms
firms
long-run
long-run cost
cost curves
curves differ
differ from
from its
its shortshortrun
run cost
cost curves.
curves.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 38

Figure 13-7: Average Total Cost in the Short


and Long Runs
Average
Total
Cost

ATC in short
run with
small factory

ATC in short ATC in short


run with
run with
medium factory large factory

$12,000

ATC in long run

1,200

Quantity of
Cars per Day

Economies
Economies and
and Diseconomies
Diseconomies of
of
Scale
Scale
Economies
Economies of
of scale
scale refer
refer to
to the
the property
property
whereby
whereby long-run
long-run average
average total
total cost
cost falls
falls
as
as the
the quantity
quantity of
of output
output increases.
increases.
Diseconomies
Diseconomies of
of scale
scale refer
refer to
to the
the
property
property whereby
whereby long-run
long-run average
average total
total
cost
cost rises
rises as
as the
the quantity
quantity of
of output
output
increases.
increases.
Constant
Constant returns
returns to
to scale
scale refers
refers to
to the
the
property
property whereby
whereby long-run
long-run average
average total
total
cost
cost stays
stays the
the same
same as
as the
the quantity
quantity of
of
output
output increases
increases
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 40

Summary
Summary
The
The goal
goal of
of firms
firms is
is to
to maximize
maximize profit,
profit,
which
which equals
equals total
total revenue
revenue minus
minus total
total
cost.
cost.
When
When analyzing
analyzing aa firms
firms behavior,
behavior, itit is
is
important
important to
to include
include all
all the
the opportunity
opportunity
costs
costs of
of production.
production.
Some
Some opportunity
opportunity costs
costs are
are explicit
explicit while
while
other
other opportunity
opportunity costs
costs are
are implicit.
implicit.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 41

Summary
Summary
A
Afirms
firms costs
costs reflect
reflect its
its production
production
process.
process.
A
Atypical
typical firms
firms production
production function
function gets
gets
flatter
flatter as
as the
the quantity
quantity of
of input
input increases,
increases,
displaying
displaying the
the property
property of
of diminishing
diminishing
marginal
marginal product.
product.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 42

Summary
Summary
A
Afirms
firms total
total costs
costs are
are divided
divided between
between
fixed
fixed and
and variable
variable costs.
costs. Fixed
Fixed costs
costs do
do
not
not change
change when
when the
the firm
firm alters
alters the
the
quantity
quantity of
of output
output produced;
produced; variable
variable
costs
costs do
do change
change as
as the
the firm
firm alters
alters quantity
quantity
of
of output
output produced.
produced.
Average
Average total
total cost
cost is
is total
total cost
cost divided
divided by
by
the
the quantity
quantity of
of output.
output.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 43

Summary
Summary
Marginal
Marginal cost
cost is
is the
the amount
amount by
by which
which total
total
cost
cost would
would rise
rise ifif output
output were
were increased
increased
by
by one
one unit.
unit.
The
The marginal
marginal cost
cost always
always rises
rises with
with the
the
quantity
quantity of
of output.
output.
Average
Average cost
cost first
first falls
falls as
as output
output increases
increases
and
and then
then rises.
rises.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 44

Summary
Summary

The
The average-total-cost
average-total-cost curve
curve is
is U-shaped.
U-shaped.
The
The marginal-cost
marginal-cost curve
curve always
always crosses
crosses
the
the average-total-cost
average-total-cost curve
curve at
at the
the
minimum
minimum of
of ATC.
ATC.
A
Afirms
firms costs
costs often
often depend
depend on
on the
the time
time
horizon
horizon being
being considered.
considered.
In
In particular,
particular, many
many costs
costs are
are fixed
fixed in
in the
the
short
short run
run but
but variable
variable in
in the
the long
long run.
run.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 45

The End

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition

Chapter 13: Page 46