Unit 3 Costs of Production (Micro)

Unit 3 Overview Lesson: Top 10 things you need to know about the production costs of a firm, including marginal analyses in the short run and long run. This video is geared toward college-level principles of macro and micro courses and students enrolled in AP Economics. Be sure to take notes while watching and pause when necessary.

Top 10 concepts in this video:

#1. Diminishing Marginal Returns

#2. Marginal Product & Average Product

#3. Economic Profit vs. Accounting Profit

#4. Types of Costs

#5. Calculating Costs

#6. Total Revenue & Marginal Revenue

#7. Profit Maximizing Rule

#8. Per-Unit Tax vs. Lump-Sum Tax

#9. Short Run vs. Long Run

#10. Long-Run Average Total Cost Curve

What is the relationship between marginal product and average product?

The marginal product and average product curves initially increase then decrease due to the law of diminishing marginal returns.

Marginal product is the change in total product divided by the change in quantity of resources (or economic inputs).

Average product is the total product divided by the quantity of economic resources (or inputs).

The average product reaches its peak when it intersects the marginal product curve.

How do you calculate the per-unit costs for a firm?

There are three types of total costs that all firms face: fixed costs (FC), variable costs (VC), and total costs (TC). Fixed costs must be paid to resource suppliers regardless of output and variable costs change with output. Fixed costs plus variable costs will equal a firm's total cost.

Per-unit costs are used to derive the firm's average cost curves, which you are expected to sketch on the AP Microeconomics exam. To get average costs, simply divide the total costs by the quantities being produced.

Average Fixed Cost = FC/Q

Average Variable Cost = VC/Q

Average Total Cost = TC/Q

Marginal Cost = Change in TC/Change in Q

How do you sketch the cost curves for a firm?

Whether you are illustrating a perfectly competitive firm or a monopolist, the unit cost curves all look the same. Here is what you should remember when sketching the curves:

1. The marginal cost (MC) curve looks like a check mark (or Nike swoosh) because of the law of diminishing marginal returns.

2. The average total cost (ATC) curve is u-shaped and must intersect the MC curve when ATC is at its lowest point.

3. The average variable cost (AVC) curve is also u-shaped, but must be below the ATC. The AVC will intersect the MC curve at the AVC's minimum. The distance between the AVC and the ATC should narrow as output increases because this distance represents the firm's average fixed costs.

How does a per-unit tax affect a firm's level of output?

A per-unit tax discourages production by raising marginal costs (MC shifts upward). This will decrease the firm's level of output and reduce its economic profits.

The average total cost and average variable cost curves also shift up, but it's the marginal cost curve that changes the profit-maximizing level of output as the MR=MC point has moved to the left.

A lump-sum tax has no effect on a firm's output as only fixed costs rise causing total costs to also rise. Profits fall, but output stays the same.

How does a per-unit subsidy affect a firm's level of output?

A per-unit subsidy encourages more production by lowering marginal costs (MC shifts down). This will increase the firm's level of output and increase economic profits.

The average total cost and average variable cost curves also shift down, but it's the marginal cost curve that changes the profit-maximizing level of output as the MR=MC point has moved to the right.

A lump-sum subsidy has no effect on a firm's output as only fixed costs fall causing total costs to also fall. Profits rise, but output stays the same.

What is meant by economies of scale?

A firm's long-run average total cost curve can be broken down into 3 components; economies of scale, constant return to scale, and diseconomies of scale.

Economies of scale occurs when the firm's long-run average total costs decrease as it increases production. While all types of firms can experience economies of scale, monopoly firms and oligopolist's tend to enjoy this phase of production over a larger range of output compared to one single perfectly competitive cucumber farmer.

Economies of scale serves as a barrier to entry in less competitive market structures.

The first level of output when the average total costs are minimized is known as minimum efficient scale as indicated by the first vertical dotted line on the left shown below.

When long-run average total costs stay the same as output increases, the firm produces at a constant return. When long-run average total costs increase as output increases, the firm is producing with diseconomies of scale.