Chapter 6 - The Costs of Production

Factor of Production
Resource inputs used to produce goods and services.

- Land
- Labor
- Capital
- Entrepreneurship
Production Function
A technological relationship expressing the MAXIMUM quantity of a good attainable from DIFFERENT combinations of factor INPUTS.

Shows relationship between Resource inputs and Product Outputs
Output per unit of input, for example, output per labor-hour

The productivity of any factor of production depends on the amount of other resources available to it.
Efficiency (technical)
MAXIMUM output of a good from the resources used in production.
Short Run
The period in which the quantity (and quality) of some inputs CANNOT be changed.

Short Run Objective is to make the BEST possible use of the factory that one has acquired.
Marginal Physical Product (MPP)
MPP = Change in Total Output / Change in Input Quantity
Law of Diminishing Returns
The MPP of a variable input (labor) declines as more of it is employed with a given quantity of fixed inputs (land, capital).
Difference between total revenue and total costs
Marginal Cost (MC)
The increase in TOTAL COST associated with a one-unit increase in production.

MC = change in total cost / change in output
Total Cost (TC)
The Market Value of ALL resources used to produce a good or service.

To determine the cost, simply identify all the resources, determine value, and add everything up.
Fixed Costs
Production Costs that don't change when the rate of output is altered.
Variable Costs
Production Costs that DO change when the rate of output is altered. (labor, material costs)
Average Total Cost (ATC)
ATC = Total Cost / Total Output


An increase in output declines ATC
Average Fixed Cost (AFC)
AFC = Total Fixed Cost / Total Output

An increase in output lowers AFC
Average Variable Cost (AVC)
AVC = Total Variable Cost / Total Output

An increase in output lowers AVC
Explicit Cost
A PAYMENT made for the use of a resource

"dollar payments"
Implicit Cost
The value of resources used, even when no direct payment is made.

Example: Instead of hiring a laborer, the owner decides to work himself.
Economic Cost
The value of all resources used to produce a good or service.

Economic Costs = Implicit Costs + Explicit Costs

Economic Costs = Accounting Profit - Implicit Costs

Long Run
A period of time long enough for all inputs to be varied (no fixed costs)

There are no commitments to existing technology.
Economies of Scale
Reductions in MINIMUM ATC that come about through increases in the SIZE of plant and equipment.
Constant Returns to Scale
Increases in plant size do NOT affect minimum ATC

Minimum Per-Unit Costs are identical for small plants and large plants.