hey everyone i'm mr willis and you will love [Music] economics [Music] during the production process firms accumulate costs as they pay the wages and rents required to purchase land labor and capital in economics all costs are economic costs because they account for both the explicit and implicit costs of acquiring inputs the explicit costs of production are the out-of-pocket cash payments paid by firms in order to acquire the land labor and capital needed to produce economic goods the implicit costs of production are the opportunity costs of using resources during the production process let's clear something up accountants and economists look at costs differently when calculating costs accountants only include the explicit or out-of-pocket costs paid by firms to use resources during the production process on the other hand economists count both the explicit and the implicit cost of production because economists are concerned with the opportunity costs and trade-offs due to the problems presented by scarcity as a result the difference between accounting costs and economic costs is the sum of the opportunity cost of using resources during the production process so how does this factor into profits for the firm when a firm sells a good in the product market the price collected per unit creates revenue for the firm in accounting if the revenue earned by the firm is greater than the explicit cost of production the firm is earning accounting profits in order for the firm to earn economic profits however the revenue earned by the firm must be greater than the sum of both the explicit costs and the implicit cost of production if the revenue earned by the firm is greater than the explicit cost of production but less than the combined sum of explicit and implicit costs the firm is earning enough revenue to cover their accounting costs but not enough to cover their economic costs this means that they're earning accounting profits by taking economic losses at the same time in economics we cut through the confusion and make things simple because all costs are economic costs any and all costs of production from here on out include both explicit and implicit costs if revenue exceeds economic costs the firm is earning economic profits if economic costs exceed revenue the firm is taking economic losses and if revenue equals economic costs the firm is breaking even when producing output firms face several different types of production costs fixed costs are the wages and rents of the fixed resources used during the production process these costs do not change with the amount of output produced and they can include rents on land interest payments on loans as well as insurance and business licensing fixed costs are often referred to as overhead costs because they must be paid regardless of production level and sometimes even before production begins variable costs are the wages and rents of variable resources used during the production process these costs do change with the amount of output produced when the firm produces more output it faces higher variable costs when the firm produces less output it faces lower variable costs variable costs include hourly wages paid to workers as well as rents paid for electricity capital equipment and raw materials total cost is the sum of the variable costs and the fixed cost of production the more output produced the higher total costs are to firms because variable costs increase as production increases the less output produced the lower total costs are to the firm because variable costs decrease as production decreases let's practice suppose an entrepreneur sets out to start a small diner in your hometown to get started the business owner is going to have to pay overhead costs on several fixed resources before opening his doors or even producing a single plate of food he has to pay rent on his store purchase fire insurance and pay for several required business licenses these overhead costs add up to 100 in fixed costs for the firm before the doors have even opened or production has even begun because fixed costs remain constant and do not change with the quantity of output produced the firm will face this 100 fixed cost of production no matter how much food they produce now in order to begin production the store owner has to combine several variable inputs including labor electricity refrigerators cooktops and other equipment when combining the wages and rents of the labor and capital required to produce the first 10 plates of food the store owner will face a variable cost of 80 however as output increases the owner will have to hire more workers and rent more equipment meaning that the variable cost of production will increase as production increases from here we can calculate the total cost of production for the diner by adding the fixed cost of production to the variable cost of production at every output level notice that fixed costs remain constant at every output level while variable costs and total cost increase as output increases also notice that the difference between the total cost and variable cost of production at each output level is the sum of fixed production costs for the firm because firms are seeking to maximize profits it is important for firms to gauge the fixed variable and total costs attributed to each unit that they produce these per unit production costs help ferbs decide the total quantity of output they should produce as well as the profit earned or loss is taken per unit of output there are four different types of per unit production costs average fixed cost average variable cost average total cost and marginal cost average fixed cost tells the firm the fixed cost of production per unit of output produced to calculate the average fixed cost per unit we simply need to take the fixed cost of production and divide it by total product average variable cost tells the firm the variable cost of production per unit of output produced to calculate the average variable cost per unit we simply need to take the variable cost of production and divide it by total product average total cost tells the firm the combined cost of both fixed and variable resources per unit of output produced in other words it tells the firm the total cost of production per unit of output to calculate the average total cost per unit we simply need to take the total cost of production and divide it by total product marginal cost is the cost of producing each additional unit of output in other words by how much will total cost increase with the production of each additional unit of a good or service to calculate the marginal cost of each unit of output we simply need to take the change in total cost and divide it by the change in total product let's take a closer look at calculating per unit production costs let's go back to that small diner in your hometown here we can see the production cost that we calculated earlier we can use the fixed cost variable cost and total cost of production at each level of output to calculate the per unit production costs for the firm let's start with the average fixed cost we can divide fixed cost by the total product at each output level to find the average fixed cost per unit next let's calculate average variable cost we can divide variable cost by the total product at each output level to find the average variable cost per unit now let's calculate average total cost we can divide total cost by the total product at each output level to find the average total cost per unit however because total cost is the sum of fixed cost and variable costs average total cost can also be found by adding the average fixed cost per unit to the average variable cost per unit and lastly let's calculate marginal cost at each output level the diner increases its total product by 10 meals as a result we can divide the change in total cost at each output level by 10 meals to find the marginal cost of producing each additional meal notice several things each of these sums represents the fixed cost variable cost and total cost of producing each meal at every output level in order to cover these production costs the diner must sell each meal at a price that is equal to or greater than the production cost per unit for example when producing 40 meals the average fixed cost of producing each meal is fifty 2.50 in order to generate enough revenue to cover their fixed production costs the diner must sell each meal at a price of two dollars and fifty cents or higher when producing sixty meals the average variable cost of producing each meal is five dollars in order to generate enough revenue to cover their variable production costs the diner must sell each meal at a price of five dollars or higher when producing 50 meals the average total cost of producing each meal is six dollars and 80 cents in order to generate enough revenue to cover their total production costs the diner must sell each meal at a price of six dollars and 80 cents or higher also notice that the fixed cost per unit gets smaller as total product increases this is because as production increases fixed production costs which remain constant are divided among more and more units of output and lastly notice that the average variable cost and the average total cost initially decrease and then increase as total product rises this is due to the law of diminishing marginal returns initially variable resources are more productive for the firm meaning each unit of output they produce has a lower variable cost then as diminishing return sets in each additional variable resource is less productive than the last causing the variable cost per unit of output to increase again let's put it this way suppose the diner hires three workers and the only variable cost is the hourly wage of ten dollars paid to each worker if the first worker can produce ten meals each meal has an average variable cost of one dollar if the second worker can produce 15 meals each meal now has an average variable cost of 80 cents however if diminishing return sets in and the third worker has a marginal product of only five meals the average variable cost of each meal would increase again to one dollar because average total cost is the sum of average fixed cost and average variable cost average total cost parallels average variable cost and the total cost per meal produced by the diner initially decreases and then increases because of diminishing returns and that's production costs be sure to subscribe to the channel by hitting the red button below so you can receive alerts about new videos when they become available if you enjoy the channel or find my videos useful let me know by liking the video and feel free to leave a comment below we have full video lectures on every topic in macro and microeconomics as well as quick macro and micro minute videos for cram sessions and quick reviews if you'd like to learn more you can click here for my micro minute video on marginal product and marginal cost or you can click here for my video on graphing production costs thank you so much for watching i'll see you next time on you will love economics [Music]