Economics, 3rd Edition

THE COSTS OF PRODUCTION

All firms, from Air France to your local baker’s shop, incur costs as they make the goods and services that 

they sell. A firm’s costs are a key determinant of its production and pricing decisions. In this chapter, we 

define some of the variables that economists use to measure a firm’s costs, and we consider the relation-

ships among them. It provides a crucial foundation for the fascinating topics that follow.

What Are Costs?

We will look at the costs of a firm using an example – Paolo’s Pizza Factory. Paolo, the owner of the firm, 

buys flour, tomatoes, mozzarella cheese, salami and other pizza ingredients. He also buys the mixers 

and ovens, and hires workers to run this equipment. He then sells the resulting pizzas to consumers. By 

examining some of the issues that Paolo faces in his business, we can learn some lessons about costs 

that apply to all firms in the economy.