other costs. While it may seem odd to treat profit as a “cost”, it is what entrepreneurs earn for taking the

risk of starting a business. You can see this correspondence between factors of production and factor

payments in the inside loop of the circular flow diagram in Figure 1.7.

We now have all the information necessary to determine a firm’s costs.

A cost function is a mathematical expression or equation that shows the cost of producing different levels of

output.

Q

1

2

3

4

Cost $32.50 $44 $52 $90

TABLE 7.3 Cost Function for

Producing Widgets
166 7 • Production, Costs, and Industry Structure

What we observe is that the cost increases as the firm produces higher quantities of output. This is pretty

intuitive, since producing more output requires greater quantities of inputs, which cost more dollars to

acquire.

What is the origin of these cost figures? They come from the production function and the factor payments. The
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