Week 9 — Lecture Outline · Production & Costs

Course: Principles of Microeconomics (ECON 1) · Silver Oak University (fictional sample) · Prof. Kessler
Objective 5 — production & cost relationships · SLO A & B
Meeting pattern: two 75-min sessions (≈150 min). Segment minutes below total ~150.

The deck (E), the tutorial (C), and the workshop (P) all teach from this outline. Every number is pre-computed and independently verified (see the verified box in §4).

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Week at a glance

Big question	Why do a firm's average costs fall and then rise — and how does marginal cost anchor the whole picture?
By week's end students can	(1) split costs into FC vs. VC and compute TC; (2) compute AFC, AVC, ATC, MC from a cost schedule; (3) explain why AFC always falls, AVC and ATC are U-shaped, and MC cuts both at their minimums; (4) distinguish accounting profit from economic profit; (5) apply the sunk-cost principle to forward-looking decisions.
Key vocabulary	short run vs. long run; fixed cost (FC); variable cost (VC); total cost (TC); average fixed cost (AFC); average variable cost (AVC); average total cost (ATC); marginal cost (MC); explicit cost; implicit cost (opportunity cost); accounting profit; economic profit; sunk cost; diminishing marginal returns
Materials	whiteboard or projector; Week-9 readings/links; a spreadsheet (Google Sheets or Excel) for the cost schedule; an approved chatbot
Timing note	8 segments ≈ 150 min across two sessions. Trim Segment 7 (interaction) if short on time.

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Segment 1 — HOOK: "Why does the first hour in the kitchen cost less than the tenth?" (10 min)

Open with a concrete scenario: "Imagine you're baking cookies for a fundraiser. You buy flour, butter, and rent oven time — those costs exist whether you make one cookie or a hundred. But the more cookies you make, the more eggs and chocolate you go through. At some point, your counter is so crowded that each extra cookie takes longer and costs more. Today we put exact numbers on that story."

Frame the week: we are going inside the firm for the first time. Weeks 1–8 treated the firm as a black box in a market. Now we open the box. Cost structure is what we find inside — and it will drive everything in Weeks 10, 11, and 12.

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Segment 2 — PLAIN-LANGUAGE IDEA: short run vs. long run & the FC/VC split (18 min)

Short run vs. long run (not calendar time — a logical distinction):
- Short run: at least one input is fixed — you can't change it quickly. A bakery has a lease; it can hire more workers this week but can't expand the kitchen overnight.
- Long run: all inputs are variable — enough time to change everything (move to a bigger building, buy another oven).

Fixed cost (FC): does NOT change with the quantity of output. Examples: rent, insurance, loan payments on equipment. Even at Q = 0, the firm owes FC.

Variable cost (VC): DOES change with quantity. More output → more labor and materials → higher VC.

Total cost: TC = FC + VC at every level of output. At Q = 0, TC = FC (VC = 0).

Build the intuition: AFC (FC/Q) must fall as Q rises — you're spreading the same fixed cost over more units. AVC and ATC are U-shaped because of diminishing marginal returns: early workers/units benefit from specialization (MC falls), but eventually crowding raises MC, which then pulls AVC and ATC back up.

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Segment 3 — WORKED EXAMPLE: the cost schedule (25 min)

Set it up on the board and fill in each column out loud, one at a time.

The firm has FC = $60. Variable costs follow a schedule driven by production.

✅ VERIFIED COST SCHEDULE (pre-computed; use these exactly)

Q	VC	TC	AFC	AVC	ATC	MC
0	0	60	—	—	—	—
1	40	100	60.00	40.00	100.00	40
2	70	130	30.00	35.00	65.00	30
3	90	150	20.00	30.00	50.00	20
4	120	180	15.00	30.00	45.00	30
5	160	220	12.00	32.00	44.00	40
6	210	270	10.00	35.00	45.00	50

• TC = FC + VC at every row. At Q=0: TC = 60 + 0 = 60.
• AFC = FC / Q — 60 divided by Q. Declines every row (60, 30, 20, 15, 12, 10). Always falls.
• AVC = VC / Q — falls then rises. Minimum AVC = 30 at Q = 3 (and ties at Q=4).
• ATC = TC / Q (equivalently, ATC = AFC + AVC). Minimum ATC = 44 at Q = 5.
• MC = ΔTC = TC(Q) − TC(Q−1) — the cost of each additional unit. MC falls then rises (40, 30, 20, 30, 40, 50).

Walk through aloud: "Q=3: VC=90, so TC=60+90=150. AFC=60/3=20; AVC=90/3=30; ATC=150/3=50. MC=150−130=20." Repeat for Q=5: "TC=220, ATC=220/5=44 — that's the cheapest way to run this firm, per unit."

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Segment 4 — THE KEY RELATIONSHIPS: why the curves look the way they do (20 min)

Four rules — teach each one, then verify it in the schedule:

1. AFC always falls — the fixed cost is the same dollar amount spread over more and more units. Can only go down. Memory: "the denominator grows; the numerator stays put."

2. ATC = AVC + AFC at every Q — check: Q=5: AVC=32 + AFC=12 = 44 = ATC. ✓ This also means as AFC falls and AVC starts rising, ATC eventually starts rising too.

3. AVC and ATC are U-shaped — they fall when MC is below them (MC "pulls down" the average), and rise when MC is above them. The turn happens exactly when MC = average. This is not a coincidence — it's the same logic as a grade average: if your new test score is below your current average, the average falls; if above, it rises.

4. MC cuts AVC and ATC at their minima — from the schedule: AVC hits minimum at Q=3 (AVC=30); MC at Q=3 is 20, which is below AVC, still pulling it down — and MC at Q=4 is 30 = AVC at Q=4. So MC crosses AVC right at the AVC minimum. ATC hits minimum at Q=5 (ATC=44); MC at Q=5 is 40 < 44, still pulling ATC down; MC at Q=6 is 50 > ATC=45, starting to pull it up. MC cuts ATC between Q=5 and Q=6. ✓

Graph logic to say aloud: "If you could draw this — AVC is the lower U, ATC is the upper U (higher because it includes AFC), and MC is the steeper curve that rises faster, passing through the bottom of AVC first, then through the bottom of ATC."

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Segment 5 — ACCOUNTING vs. ECONOMIC PROFIT: the cost you can't see on an invoice (15 min)

Explicit costs: paid with a check — wages, rent, materials. These show up on the income statement.

Implicit costs: the opportunity cost of resources the owner brings in without a payment — most commonly the owner's own time (forgone salary elsewhere), or the owner's own capital (forgone investment return).

Accounting profit = Total Revenue − Explicit Costs (what accountants track).

Economic profit = Total Revenue − Explicit Costs − Implicit Costs = Accounting Profit − Implicit Costs.

Economic profit can be negative even when accounting profit is positive — if the owner could be doing better elsewhere, there's an economic loss even with money coming in.

Example (verbal): a shop earns $80,000/yr revenue, has $50,000 explicit costs → accounting profit = $30,000. But the owner gave up a $40,000 salary to run the shop → implicit cost = $40,000. Economic profit = $30,000 − $40,000 = −$10,000 (an economic loss). The owner might stay (they like being the boss), but they're paying $10,000/yr for that privilege.

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Segment 6 — TECHNOLOGY WORKFLOW + AI-CRITIQUE (20 min)

Live demo (spreadsheet): enter the verified cost schedule in Google Sheets: columns Q, VC, TC, AFC, AVC, ATC, MC. Use formulas — AFC = 60/Q, TC = 60 + VC, MC = TC(Q) − TC(Q−1). Let students see the numbers fall into place. Point out the ATC minimum (Q=5 = 44).

AI-critique moment: Ask an approved chatbot: "A firm has FC=60 and VC schedule: Q=1 VC=40, Q=2 VC=70, Q=3 VC=90, Q=4 VC=120, Q=5 VC=160. At what quantity is ATC minimized, and what is the minimum ATC?" Then audit: correct answer is Q=5, ATC=44. Chatbots frequently: (a) confuse MC with ATC minimum, (b) compute ATC as VC/Q (forgetting to add FC), or (c) give Q=3 because they confuse AVC minimum with ATC minimum. Have the class catch the error.

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Segment 7 — INTERACTION: think-pair-share (12 min)

Pose: "A restaurant owner has already paid $10,000 in non-refundable kitchen renovation costs. Now, halfway through, she asks: 'Should I spend another $8,000 to finish?' A friend says 'Of course — you've already spent $10,000!' What does an economist say, and why?"

Target answer: the $10,000 is a sunk cost — already spent, can't be recovered, so it is irrelevant to the forward-looking decision. The only things that matter are the future $8,000 cost vs. the future benefit of the finished kitchen. Sunk costs cannot be changed; only marginal costs and benefits matter going forward.

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Segment 8 — CALLBACKS, TEASE & THE WEEK'S WORK (10 min)

• Callback: all of today's cost curves come from one root — diminishing marginal returns in the short run. MC falls with specialization, then rises as workers crowd limited space. Everything else (U-shaped AVC/ATC, MC cutting at minimums) follows.
• Tease next week: "Now that we have the firm's cost curves, we can answer the question: 'At what price does it actually want to produce — and when does it pay to shut down entirely?' That's Week 10: perfect competition."
• The week's work: Lecture Tutorial, Practice, Quiz 9, Discussion 9 (the sunk-cost fallacy), Assignment 9, and Workshop 9 (build the cost schedule in a spreadsheet and catch the AI's cost-table errors).

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Instructor FAQ — common stumbles

• "Why does AFC always fall?" FC is a constant dollar amount (say, $60). Divide it by 1, 2, 3, 4... the number shrinks. There's no scenario where spreading a fixed cost over more units makes the per-unit fixed cost higher.
• "Is ATC minimum the same as AVC minimum?" No — ATC includes AFC, so ATC lies above AVC. Because AFC keeps falling as Q rises, the ATC minimum occurs at a higher Q than the AVC minimum. In the schedule: AVC min at Q=3, ATC min at Q=5. ✓
• "MC cuts them both at their minimums — is that a coincidence?" No — it's pure arithmetic (the average/marginal relationship). If the marginal is below the average, the average falls; if above, it rises. The turn happens exactly where marginal = average.
• "Economic profit is negative — but the firm is profitable on the accountant's books. Should it close?" Not necessarily. If economic profit is negative but greater than the loss of shutting down (which would be −FC in the short run), it may still be rational to operate. Full treatment next week.
• "What's a sunk cost exactly?" A cost already paid that cannot be recovered regardless of the decision you make now. Irrelevant to forward-looking choice. The classic error: factoring it in because "I already paid for it" — that's the sunk-cost fallacy.