[Mankiw principles of economics 14] 14.The Costs of Production

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This video, titled "The Costs of Production," explains how economists view costs and profits, which differs significantly from the accounting perspective [00:29]. The core idea is that a business's true success is measured by its economic profit, not just its accounting profit [01:05].

Key Concepts:
Accounting Profit vs. Economic Profit

Accounting Profit is what most people think of as profit. It's calculated by subtracting explicit costs (money actually paid out, like rent and wages) from total revenue [00:42].

Economic Profit provides a more complete picture by subtracting both explicit and implicit costs from total revenue [02:28]. Implicit costs are the opportunity costs—what you give up to run the business, like a salary from a job you quit [01:16, 01:35]. A positive economic profit means the business is a good decision [02:34].

Production Function and Diminishing Marginal Product

The production function is the relationship between the inputs (like workers) and the outputs (the goods produced) [02:59].

A key concept here is diminishing marginal product: as you add more of one input (e.g., workers) while keeping other inputs fixed (e.g., the size of the factory), the extra output you get from each additional unit of input will eventually decrease [03:44]. Think of it like too many cooks in a small kitchen—they start getting in each other's way [03:56].

Cost Curves

Fixed Costs don't change with the level of production (e.g., rent) [04:25].

Variable Costs change with the level of production (e.g., raw materials) [04:31].

Total Cost is the sum of fixed and variable costs [04:37].

Marginal Cost is the most important for decision-making. It's the cost of producing one more unit of a good [04:48]. The "golden rule" is that the marginal cost curve always intersects the average total cost curve at its lowest point [05:22].

Short Run vs. Long Run

In the short run, at least one input is fixed (like the size of the factory) [05:49].

In the long run, all inputs are variable. The business can change everything, like building a bigger factory [06:00].

In the long run, businesses can experience:

Economies of scale: Average costs fall as production increases [06:26].

Constant returns to scale: Average costs stay the same as production increases [06:32].

Diseconomies of scale: Average costs rise as production increases, often due to coordination problems in a large organization [06:39].