Introduction to

Economics
8.Lecture
04.12.2023
DR. TANJU ÖZDENİZ
İSTANBUL KENT UNIVERSITY, 2023
 Production, Costs
and Firm Behavior

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

2023
 Cost

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY I2023

 COST
• The concept of cost is one of the most important decisions that
companies have to take.
• A company wants to maximize its profit must first know its cost
structure.
• The firm has to pay for the production inputs it will use in order to
produce.
• These payments made by the firm will constitute the cost of the firm.
Since the firm does not have infinite resources, the firm has to make a
choice when it takes a certain decision.
• When the firm makes this choice, it means giving up certain
opportunities or alternatives.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 COST
• For example, the firm will make payments such as wages for the use of labor
and rent for the shop.
• Well, if the owner of the company works in his own shop, is there any cost in
this case?
• Economists treat the concept of cost differently from the way it is used in
daily life or from accounting costs.
• In the accounting systems , the payments coming out of the firm's safe,
machinery depreciation (depreciation) and earnings entering the firm's safe
are recorded.
• Since economists are concerned with the efficient allocation of scarce
resources, they also take into account some costs that are not included in the
accounting records.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Opportunity Cost
• In economic theory, cost is defined in terms of other alternatives we
have to give up to get something, and this concept is called
Opportunity Cost.
• Opportunity cost results from not using an input in its best alternative
for the firm.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Opportunity Cost
• Let's go back to the question we asked above. Suppose the firm operates in its
own shop and does not pay rent. Does the company have any costs? From an
accounting point of view, there is no payment made from the firm's cash register.
However, economically speaking, there is.
• Because if the company had not used the shop for its own business, it could have
rented it out to someone else and earned rental income.
• Since the company uses the shop itself, it gives up its rental income. This
foreclosed gain is the opportunity cost. Similarly, suppose the owner of the firm is
at his own business and does not receive a salary from the cash register. As long as
there is no exit from the firm's cash desk, this will not be included in the
accounting records, as there is no monetary exchange. However, there is an
opportunity cost, as the owner of the company forgoes the wages that he can earn
as a manager by working in his own business in another company.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Opportunity Cost
• Let us try to explain the difference between Opportunity Cost
(Economic Cost) and Accounting Cost with a simple example.
• Let's assume that Ahmet Bey, who keeps computerized accounting
records at Company A with a monthly fee of 2000 TL, bought a bagel
bakery with 120,000 TL inherited from his father and took over the
business. It is stated that 1500 bagels are produced daily in the oven,
and that each bagel is 50krs. Assuming that it is sold from, Company A
will have a daily sales income of 750 TL. Suppose the firm's daily
production costs are as follows.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Opportunity Cost

Flour 350,00 ₺

Electricty 75,00 ₺

Water and other additives 25,00 ₺

Daily wage for the chef 100,00 ₺

Daily wage for the assistant 50,00 ₺

Total 600,00 ₺

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Opportunity Cost
• In this case, the daily production cost of the firm will be 600 TL. These
costs are those that are paid directly from the company's coffers. In
economic theory, we call such costs Explicit Costs.

• The owner of the company, Ahmet Bey, keeps the daily cash and
accounting records of the company. According to his own
calculations, Mr. Ahmet earns a profit of 150 TL per day and 4500 TL
per month for 30 days. Is this calculation of Ahmet Bey correct?

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Opportunity Cost
• Ahmet Bey's calculation is wrong when we consider the concept of
opportunity cost.
• First of all, Mr. Ahmet made a monthly income of 2000 TL by running
his own company. This is the opportunity cost of Ahmet Bey being the
head of his own business.
• Secondly, Mr. Ahmet paid 120.000 TL to buy the bagel oven. What is
the opportunity cost of this capital? If the annual interest rate in the
economy is 10 percent, Ahmet Bey gave up his annual interest income
of 12.000 TL. In this case, the monthly forgone interest yield is
approximately 1000 TL. This is the opportunity cost of Ahmet's
capital. These types of costs are called Implicit Costs.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Opportunity Cost

• This is where the difference between economic cost and

accounting cost arises.
• While accounting cost only considers explicit costs such
as direct payments, purchases in the market, economic
cost considers both explicit and implicit costs.
• In this case, Ahmet Bey's economic profit is not 4500TL
per month, but 4500 – 3000 = 1500TL.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Sunk Cost
• Although the opportunity cost is an implicit cost and is not included in the
accounting records, it must be taken into account in economic decisions. The
opposite is true for sunk costs. Let's consider a machine that a company
bought 2-3 years ago by making an investment, but is now useless and has no
alternative use. A wrongfully purchased machine is a sunk cost if it cannot be
repurposed, rented, or sold.
• The amount paid to the machine is naturally included in the accounting
records. However, the opportunity cost of sunk cost is zero and is not taken
into account in future economic decisions. For example, the construction of
Ayaş Tunnel, which took years to build (starting in 1976) and around 200
million dollars was spent, resulted in wrong planning, wrong ground survey,
etc. It is an investment that has been abandoned due to reasons such as:
Money spent here is a complete sunk cost.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 "wear and tear" and "depreciation"

Similarly, the assessment of «wear and tear» also differs in

terms of accounting and economic costs.
In accounting records, depreciation can be deducted at
standard rates as determined by tax laws. This ratio often
does not reflect the actual depreciation of machinery and
equipment.
When evaluating economic costs, the actual «wear and
tear» of capital goods is taken into account.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Explicit Cost, Implicit Cost, Sunk Cost
• Explicit costs are the costs that come out of the firm's
coffers and are directly included in the accounting
records.
• Costs that reflect opportunity costs and are not included
in the accounting records are implicit costs.
• Sunk costs are expenditures made on an investment that
have no alternative use and cannot be recovered.
Although sunk costs are included in the accounting
records, they are not considered economic costs.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Cost in the Short Run
As we examined in the production section, at least one of the production inputs is
fixed in the short run. Suppose the firm uses two inputs, one labor (L) and the other
capital (K). Let capital be fixed input from these inputs.
When the firm increases the amount of production in the short run, the amount of
capital will remain constant, only the use of labor will change. If we look at the
situation in terms of the costs that the firm will face, the amount the firm pays for the
use of capital will not change. We call these costs fixed costs in economic theory.
Note that the fixed cost is independent of the firm's output. Even if the firm does not
produce at all, it faces fixed costs. The costs that increase as the production amount of
the firm increases are called variable costs. In our example, since the variable input is
the use of labor, the wage payments that the firm will face are variable costs. The firm
uses more labor to increase its production, and the increase in the use of labor
increases the wage payments (variable cost) that the firm will face.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Cost in the Short Run

• More generally, payments made to factors that are fixed in the short
run constitute the firm's fixed costs, while payments to all variable
inputs constitute variable costs.
• For example, in a livestock enterprise, since land, animal shelters,
machinery and equipment constitute fixed production inputs in the
short run, the payments made to them constitute fixed costs. The
enterprise pays these costs whether it breeds animals or not.
Increasing the number of animals fed by the enterprise does not
increase these costs. On the other hand; Costs such as feed, water,
maintenance labor, veterinary payments are variable costs and these
costs will increase as the number of livestock increases.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Cost in the Short Run
• The firm's short-term Total Cost (TC) consists of Total Fixed Costs (TFC)
and Total Variable Costs (TVC). This relationship:
• We can write it as TC = TFC + TVC.

• If we want to examine how the costs per product change as the

production amount of the firm increases, we need to use the concept
of Average Cost (AC). If we show the product quantity with (Q), the
average cost can be found by dividing the total cost by the product
quantity.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Cost in the Short Run
In this case

If we pay attention, the TFC/Q relationship is the average fixed cost,

and the TVC/Q relationship is the average variable cost. In that case:

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Cost in the Short Run
• One of the concepts that the company needs most when making a
decision is the concept of marginal cost.
• Marginal Cost (MC) shows how the total cost will change if the firm
wants to increase its output by one more unit. Δ can also be defined
as Marginal Cost to show the amount of change in the variable.

• In this case

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Cost in the Short Run
• So marginal cost is equal to the sum of marginal fixed cost and
marginal variable cost.
• Since the fixed cost does not change when the firm increases its
output, the marginal fixed cost is equal to zero. So, marginal cost
arises only from marginal variable cost.
• To facilitate the understanding of these concepts, we can use Cost
Tables, similar to the one we use in the production part.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Total Cost, Average Cost , Marginal Cost in Short Run
Daily Total Total Fix Total Average Average Average Mariginal
Production Cost Cost Variable Cost Cost Fix Cost Variable Cost Cost
Kg TL TL TL/Kg TL/Kg TL/Kg TL/Kg TL/Kg
0 60 60 0
1 90,3 60 30,3 90,3 60 30,3 30,3
2 112,7 60 52,7 56,3 30 26,3 22,3
3 129 60 69 43 20 23 16,3
4 141,3 60 81,3 35,3 15 20,3 12,3
5 151,7 60 81,7 30,3 12 18,3 10,3
6 162 60 102 27 10 17 10,3
7 174,3 60 114,3 24,9 8,6 16,3 12,3
8 190,7 60 130,7 23,8 7,5 16,3 16,3
9 213 60 153 23,7 6,7 17 22,3
10 243,3 60 183,3 24,3 6 18,3 30,3
11 283,7 60 223,7 25,8 5,5 20,3 40,3
12 336 60 276 28 5 23 52,3
13 402,3 60 342,3 30,9 4,6 26,3 66,3
14 484,7 60 424,7 34,6 4,3 30,3 92,3

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Cost in the Short Run
• Total fixed cost of the firm is 60 TL. If we pay attention, the fixed cost
does not change even though the production amount increases. The
total variable cost given in the fourth column of the table is directly
proportional to the amount of production and as the amount of
production increases, the variable cost also increases. We can
examine the relationship between total cost and the amount of
production more closely by using the concepts of average and
marginal cost.
• The average cost is given in the 5th column of the table. If we pay
attention, AC starts from 90.3 TL kg and decreases continuously as
the production amount increases. This is due to dividing a fixed
number by an increasing number.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Cost in the Short Run
• If we examine the average variable cost of the firm, we find that the
average variable cost starts from 30.3 TL/kg, the average variable cost
decreases as the production amount increases, 7 - 8 kg. 16.3 kg in
production quantity. We observe that it reaches a minimum with This
is also true in terms of marginal cost. But first, let's calculate the
marginal cost together. For example, the production amount goes up
from 3 kg. to 4 kg. , the marginal cost is:

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Cost in the Short Run
• Our calculation of marginal cost from TC or TVC does not change the
result. As we mentioned above, this is due to the fact that the fixed
cost is independent of the amount of production.
• Marginal Cost starts from the same value as the average variable cost
and decreases faster than the average variable cost by 5-6 kg.
production amounts to a minimum with 10.3 TL kg and then starts to
increase. If you pay attention, 8 kg. in production amount, AVC and
MC are equal to each other. This point is the point where the AVC is
minimum.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Cost in the Long Run
• In the long run, the firm has the opportunity to change all its inputs.
As we assumed above, if the firm uses two inputs, capital and labor, it
tries to find the input combination that will minimize its costs by
changing its capital structure in the long run.
• In the long run, the firm has to decide on the size of the production
facility, in other words, the scale of the facility. Therefore, the long
run is a planning period for the firm.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Cost in the Long Run
• This production facility he will choose will be the facility that is expected
to minimize average costs in the long run. When the company completes
its plans and decides on the size of the production facility, it will realize
this facility through its investments.
• If attention is paid, when this planning period is completed and the firm
makes the investment, the firm now works on a fixed capital structure,
that is, it returns to the short term. After the plant is completed, the
firm's output will be determined again on a fixed capital investment by
adjusting the variable inputs.
• It is a long-term planning period. The firm decides the size of the facility
in the long run. The company, which once established its facility, makes
its production in a short period of time.
DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023
 Economies of Scale
• In the long run, the firm benefits from economies of scale by
increasing its facility size.
• The reason for the decrease in long-term average costs is that the
company can use more specialized machinery and equipment by
increasing the scale; is to increase its total productivity by specializing
its workforce in different fields. In this way, the firm can reduce its
long-run average costs.
• In the long run, firms benefit from increasing returns to scale, and as
the amount of production increases, their long-run average cost
decreases.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 Economies of Scale
As the firm's facility capacity grows, management and communication
challenges arise and the firm faces diminishing returns to scale. In the
case of decreasing returns to scale, the long-term average costs of the
firm begin to increase.

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023

 04.12.2023

DR. TANJU ÖZDENİZ I İSTANBUL KENT UNIVERSITY II2023