The document discusses the costs of production for a firm. It defines fixed costs as costs that do not vary with output, variable costs as costs that vary with output, and total costs as the sum of fixed and variable costs. Marginal cost is defined as the change in total cost from producing one additional unit of output. In the short run, costs are classified as either fixed or variable, but in the long run most costs can become variable. Cost curves like average total cost, average variable cost, and marginal cost are discussed and how they relate to costs and production levels.

1. The Cost of Production
Each firm uses various inputs (resources) in its production activity.
Commonly used inputs: labor and capital
Prices of inputs (wages, rents)  Cost of Production

2. Measuring Cost: Which Costs Matter?
It is clear that if a firm has to rent equipment or buildings, the
rent they pay is a cost
What if a firm owns its own equipment or building?
How are costs calculated here?

3. Measuring cost:
Accounting Cost – actual expenses plus depreciation charges
for capital equipment.
Economic Cost – cost to a firm of utilizing economic resources
in production, including opportunity cost.
Opportunity cost – the value of a highest forgone alternative;
– cost associated with opportunities that are forgone when a
firm’s resources are not put to their highest-value use.
Example when economic cost differs from accounting cost:
-shop owner who does not pay herself a salary and/or
owns the building

4. Economic cost.
Some costs vary with output, while some remain the same no
matter amount of output
Fixed Cost (FC) – cost that does not vary with the level of output.
- have to be paid as long as the firm stays in business (even if
output is zero)
Variable Cost (VC) – cost that varies as the level of output varies.
Total Cost (TC or C) – total economic cost of production,
consisting of fixed and variable costs.
TC=FC+VC

5. Which costs are variable and which are fixed depends on the
time horizon
Short time horizon – most costs are fixed
Long time horizon – many costs become variable
In determining how changes in production will affect costs, we
must consider if it affects fixed or variable costs

6. A Firm’s Short Run Costs

7. Cost Curves for a Firm
Output
Cost
($ per
year)
100
200
300
400
0 1 2 3 4 5 6 7 8 9 10 11 12 13
VC
Variable cost
increases with
production and
the rate varies with
increasing &
decreasing returns.
TC
Total cost
is the vertical
sum of FC
and VC.
FC50
Fixed cost does not
vary with output

8. • Costs that are fixed in the short run may not be
fixed in the long run
• Typically in the long run, most if not all costs
are variable

9. Per-Unit, or Average, Costs
Average Total cost – firm’s total cost divided by its level of output
(average cost per unit of output)
ATC=AC=TC/Q
Average Fixed cost – fixed cost divided by level of output (fixed
cost per unit of output)
AFC=FC/Q
Average variable cost – variable cost divided by the level of
output.
AVC=VC/Q

10. Marginal Cost – change (increase) in cost resulting from the
production of one extra unit of output
Denote “∆” - change. For example ∆TC - change in total cost
MC=∆TC/∆Q
Example: when 4 units of output are produced, the cost is 80,
when 5 units are produced, the cost is 90. MC=(90-80)/1=10
MC=∆VC/∆Q
since TC=(FC+VC) and FC does not change with Q

11. A Firm’s Short Run Costs

12. Cost Curves
0
20
40
60
80
100
120
0 12
Output (units/yr)
Cost($/unit)
MC
ATC
AVC
AFC

13. Marginal Product and Costs
Suppose a firm pays each worker $50 a day.
Units of
Labor
Total
Product
MP VC MC
0 0 10 0 5
1 10 15 50 3.33
2 25 20 100 2.5
3 45 15 150 3.33
4 60 10 200 5
5 70 5 250 10
6 75 300

14. Short-run Costs and Marginal Product
• production with one input L – labor; (capital is fixed)
• Assume the wage rate (w) is fixed
• Variable costs is the per unit cost of extra labor times the
amount of extra labor: VC=wL
Denote “∆” - change. For example ∆VC is change in variable cost.
MC=∆VC/∆Q ; MC =w/MPL,
where MPL=∆Q/∆L
With diminishing marginal returns: marginal cost increases as
output increases.

15. Shifts of the Cost Curves
Changes in resource prices or technology will cause costs to chan
Cost curves shift
FC increases by 100

16. Shift of FC curve
Output
Cost
($ per
year)
100
200
300
400
0 1 2 3 4 5 6 7 8 9 10 11 12 13
VC
TC
FC50
FC’150
TC’

17. Summary
In the short run, the total cost of any level of output is the sum of fixe
and variable costs: TC=FC+VC
Average fixed (AFC), average variable (AVC), and average total cos
(ATC) are fixed, variable, and total costs per unit of output; margina
cost is the extra cost of producing 1 more unit of output.
AFC is decreasing
AVC and ATC are U-shaped, reflecting increasing and then diminish
returns.
Marginal cost curve (MC) falls and then rises, intersecting both AVC
and ATC at their minimum points.