CHAPTER 30
Costs of Production
LEARNING OBJECTIVES
Explain the difference between long-run and short-run costs.
Define and graph fixed, variable, average, and marginal costs.
OUTLINE OF CHAPTER
I. Short-Run Costs and the Production Function
II. Fixed, Variable, and total Cost
III. Direct and Indirect Costs
KEY TERMS
accounting profit
the total revenue received from production and sales (p * q) minus direct or explicit costs like
labor, rent, and payments for machinery
marginal cost (MC)
the incremental cost of producing the next unit of output
negative economic profit
condition in which the owner is not doing as well as the next best alternative
positive economic profit
situation in which the owner is not only earning an accounting profit but is also doing better
than his or her next best alternative
total cost (TC)
ANSWERS TO END OF CHAPTER REVIEW QUESTIONS
Explain the difference between long-run and short-run costs.
1. What is the difference between the long run and the short run?
2. How do short-run and long-run costs differ? Why?
3. Sketch graphs to illustrate costs in the short run and long run.
4. The text lists three examples of fixed costs fire insurance premiums, security guard
services, and existing debt payments. List and discuss three additional fixed costs for a
manufacturing firm.
Define and graph fixed, variable, average, and marginal costs.
5. Explain how and whether each of the following would affect short-run marginal,
variable, fixed, and total costs:
a. wage rate paid to assembly-line workers increases
b. salary paid to upper management increases
c. firm is required to implement new environmental controls
d. price of oil decreases
Marginal, variable, and total costs
e. demand falls, so firm cuts back on production
Marginal, variable and total costs
f. property taxes rise
Marginal, variable and total costs
6. Indicate true, false, or uncertain for the following statements, and explain why:
a. AVC = ATC in the short run.
False. ATC = AFC + AVC
c. Average fixed cost falls as production proceeds through stages I and II; it begins
False. Average fixed costs falls throughout.
d. Marginal cost intersects the minimum point of the average fixed cost.
e. ATC = AVC = AFC at Q = 0.
False. ATC and AFC are undefined at Q = 0. AVC = 0.
f. In the short run, an increase in factor prices causes the marginal cost to intersect
Explain the relationship between the costs of production and productivity.
Calculate and explain the significance of positive, negative, and zero economic profits.
7. Explain the difference between accounting and economic profits. What is included in
calculating economic profits that is not included in accounting profits?
Accounting profit is total revenue minus explicit costs. Economic profit starts with
8. What is the difference between normal (or zero), positive, and negative economic –
profits?
A positive economic profit means the owner is not only earning an accounting profit but
9. Would a business owner want to stay in business if the economic profit is negative?
Explain why or why not.
A business owner may stay in business if the economic profit is negative in the short run,
the business.
10. If a business owner is earning a zero or normal economic profit, what does that mean?
11. If a business owner is earning a zero or even negative economic profit, does that mean
the accounting profit is negative? Explain.
A business owner may be earning a zero economic profit but a positive accounting profit.
APPENDIX 30.1
Costs in the Long Run
LEARNING OBJECTIVES FOR APPENDIX 30.1
Explain why there are no fixed costs in the long run.
Define and graph long-run costs.
OUTLINE OF APPENDIX
I. Production in the Long Run
II. Shifting Long Run Cost Curves
III. Costs in the Real World
IV. Summary
KEY TERMS
diseconomies of scale
situation in which average costs will rise if the scale of operation is expanded
economies of scale
ANSWERS TO APPENDIX 30.1 REVIEW QUESTIONS
Explain why there are no fixed costs in the long run.
1. Are there any fixed inputs in the long run? Why not? What does that mean for costs in
Define and graph long-run costs.
2. Indicate true, false, or uncertain for the following statements, and explain why:
a. In the long run, advancing technology makes the optimal plant size smaller.
smaller or the same size.
b. The long-run average cost envelope curve is tangent to the minimum points of the
short-run average total cost curves.
False. Only if the long run cost curve is flat. The long run cost curve is tangent to the
Explain the relationship between the long-run costs of production and productivity
(economies and diseconomies of scale).
3. What is happening to the average total costs of production when there are economies of
scale? What are explanations for economies of scale?
4. What is happening to the average total costs of production if there are diseconomies of
scale? What are explanations for diseconomies of scale?
Average total costs are rising as output rises. Diseconomies of scale are associated with
Describe how real-world considerations affect the analysis of costs and production
decisions in the long-run.
5. Suppose you fear competition from a low-cost foreign rival. Recognizing that labor
costs are your largest cost of production, you decide to announce a 10 percent across-the-
board wage reduction. Do you think this action would affect the productivity of labor?
Why or why not?