Cost of Production: Concepts and Cost Curves: quick revision, 15 bites

Cost is the Sum of Explicit and Implicit Costs

Cost isn't just what you pay.

In economics, **cost of production** includes both the payments made to outsiders (explicit costs) and the value of self-owned resources used (implicit costs).

Takeaway. Economic cost = explicit cost + implicit cost; ignoring implicit cost understates true cost.

Fixed Cost vs Variable Cost

Some costs stay, some vary.

Takeaway. Fixed costs are unavoidable in the short run; variable costs change with output.

Total Cost = TFC + TVC

The master cost equation.

Takeaway. Total cost is the sum of total fixed cost and total variable cost at every output level.

Average Cost Formulas

Per-unit cost measures.

Takeaway. AC = AVC + AFC; each average cost is its total divided by output.

Marginal Cost: Cost of One More Unit

The cost of the next unit.

Takeaway. Marginal cost is the addition to total cost from producing one extra unit; it is independent of fixed cost.

Fixed vs Variable Cost: Key Differences

Two cost types, one clear contrast.

Takeaway. Fixed costs are sunk in the short run; variable costs drive production decisions.

Shape of the Short-Run Cost Curves

Why cost curves look the way they do.

Takeaway. The U-shape of AVC, AC, and MC reflects initially increasing then diminishing returns.

Don't Confuse Fixed Cost with Sunk Cost

Fixed cost isn't always sunk.

Takeaway. Fixed cost ≠ sunk cost; sunk cost is a subset of fixed cost that cannot be recovered.

Real-World Example: A Bakery's Costs

See costs in a real business.

Takeaway. Real businesses separate fixed and variable costs to price products and plan output.

Exam Tip: Relationship Between AC and MC

Ace the AC-MC relationship.

Takeaway. Remember: MC pulls AC in its direction; the intersection is AC's minimum.

Remember: TFC is a Straight Line

Fixed cost never bends.

Think of **TFC** as a flat road—it doesn't go up or down with output. **TVC** starts at zero and climbs like a hill. **TC** is TVC lifted up by the height of TFC.

Takeaway. Visualize TFC as horizontal, TVC rising from origin, and TC parallel to TVC.

Why Cost Curves Matter for Firms

Cost curves drive supply decisions.

Takeaway. Understanding cost curves is essential for profit maximization and supply analysis.

AFC Never Touches Zero

AFC keeps falling but never hits zero.

As output increases, **AFC** (= TFC/Q) keeps decreasing but never becomes zero because TFC is positive and Q is finite. It approaches the horizontal axis asymptotically.

Takeaway. AFC is a rectangular hyperbola—it never intersects either axis.

Don't Mix Up Short Run and Long Run

Time period changes everything.

Takeaway. Fixed costs exist only in the short run; the long run has no fixed costs.

Quick Formula: AC = AVC + AFC

One formula to remember them all.

Takeaway. This identity helps derive one average cost from the other two.