What is the cost of production?
Cost of Production is the value of money used in production. Cost is further divided into two explicit costs and Implicit costs. Explicit cost Require an outlay of money e.g., paying wages to workers. Whereas, Implicit costs do not require a cash outlay e.g., the opportunity cost of the owner’s time.
Total cost = Explicit Costs + Implicit costs
Total Revenue (TR) is the amount a firm receives to sell its output.
TR = P.Q
Total Cost (TC) is the market value of the inputs a firm uses in production.
TC = ATC.Q
Profit is total revenue minus total cost.
Profit = TR – TC
Accounting Profit = TR – Explicit Cost
Economic Profit = TR – (Explicit cost + Implicit cost)
Due to the law of diminishing marginal product, output increases as the number of workers increases output, but the output is increasing at a decreasing rate.
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| Cost of Production |
Notice that as the number of workers is increasing, marginal product declines, and this property is known as diminishing marginal product.
Due to the law of diminishing marginal product, as output increases due to an increase in total cost, the output is increasing at a decreasing rate.
In the short-run fixed cost remain fixed e.g., equipment shared by the workers remain constant as the number of workers increases. Therefore, more workers share set equipment and space in the short run.
The Various Measures of Cost
Average total cost (ATC) is total cost divided by the quantity of output
Average fixed cost (AFC) is fixed cost divided by the quantity of output
Average variable cost (AVC) variable cost divided by the quantity of output
Marginal cost (MC) is the increase in total cost that arises from an extra unit of production.
The following figure shows the average total cost (ATC), average fixed cost (AFC),
average variable cost (AVC), and marginal cost (MC) for firm “X’. These cost curves show
three common features:
The marginal cost rises with the quantity of output.
The average total cost curve is U-shaped.
The marginal cost curve crosses the average total cost curve at the minimum of the average total cost.
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| Relationship MC ATC AVC & AFS |