2. ECONOMIC VERSUS ACCOUNTING
COSTS
โข Accounting costs
โข Are tangible measurements of what it costs to produce a good or
service
โข EX: Rent, Utilities, Wages
โข Economic costs
โข Are the opportunity costs of any resource used to produce a good or
service (or the value or worth the resource would have if used in its next
best alternative use.
3. EXPLICIT VERSUS IMPLICIT COSTS
โข Explicit Costs
โข Similar to Accounting Costs
โข Monetary payments to suppliers of resources = accounting costs
โข Implicit Costs
โข Similar to Economic Costs
โข Opportunity costs of self-owned resources
โข Money payments of self-employed resources that could have been earned in
their next best alternative use = economic costs
4. SELF-OWNED RESOURCES
โข EXAMPLE
โข You work at a job at a large
company
โข Your salary is $75,000 per year
โข If you gave up your job to go into
business for yourself, your economic
costs would equal $75,000.
5. TOTAL COSTS
โขTotal costs =
Explicit costs + (Implicit costs + normal profits)
โข Normal profits are what you would pay
yourself (over and above your foregone wages)
for your entrepreneurial skills and your
entrepreneurial risks.
6. ACCOUNTING PROFIT
โข The amount left over from Total
Revenue after you subtract EXPLICIT
COSTS
Total Revenue โ Explicit Costs =
Accounting Profit
7. ECONOMIC PROFIT
โข The amount left over from Total Revenue
after you subtract Total Cost (explicit costs
+implicit costs + normal profits):
Total Revenue (TR) โ Total Costs (TC) =
Economic Profits
8. MUSIC SHOP EXAMPLE
โขLetโs see if it is a good
idea for us to open a
music shop
โขWe need to calculate our
costs, both explicit and
implicit.
9. MUSIC SHOP EXAMPLE
Total Revenue = $200,000
Explicit Costs
Cost of inventory = $50,000
Payroll = $35,000
Rent = $25,000
Utilities = $5,000
= Total (explicit) costs = $115,000
Accounting profits = $85,000
10. MUSIC SHOP EXAMPLE
โข BUTโฆ
We still need to see if it is worth for us to leave our
current job to open this music store.
We need to calculate implicit costs and normal profits
too!
11. MUSIC SHOP EXAMPLE
Implicit Costs
Foregone wage = $40,000
Foregone interest = $5,000
- on the $75,000 investment needed to start the
business
Normal Profit
Entrepreneurial income = $10,000
Total (implicit) cost = $55,000
12. ECONOMIC PROFITS
โขRemember!
Total Revenue โ Total Costs = Economic Profits
$200,000 โ ($115,000 + $55,000) = $30,000
Economic Profits should equal or exceed normal profits for a person to
open/start this business
$30,000 > $10,000 (entrepreneurial income/normal profits)
15. SHORT RUN PRODUCTION TERMS
โข Total Production (TP) = Total quantity produced or total output of a
good or service
โข Marginal Product (MP) = Extra output or quantity produced by adding
one more unit of a variable resource (EX: labor)
โข Average Product (AP) = Output per unit of a variable resource (EX:
labor)
โข AP = TP รท units of variable labor
16. SHORT RUN PRODUCTION TERMS
โข Law of Diminishing Returns โ As successive units of a
variable resource (EX: labor) are added to production, marginal
production will decline as each successive unit of the variable
resource is added.
17. SHORT RUN COST TERMS
โข Fixed Costs (FC)
โข Costs associated with production that do not change regardless of the
amount produced
โข Rent, mortgage, start-up costs, payments on machinery, etc.
โข Variable Costs (VC)
โข Costs associated with production that change as the amount produced
changes
โข Labor, raw materials, utilities, etc.
18. SHORT RUN COST TERMS
โข Average Total Costs (ATC)
โข Total costs divided by the number of units produced (i.e. output or โQโ)
โข Average Fixed Costs (AFC)
โข Total fixed costs divided by the number of units produced (i.e. output
or โQโ)
โข Average Variable Costs (AVC)
โข Total variable costs divided by the number of units produced (i.e.
output or โQโ)
19. SHORT RUN COST TERMS
โขMarginal Cost (MC)
โข The increase in Total Cost of producing
ONE MORE (i.e. โmarginalโ) unit of a good
or service
โข Or the Change in Total Cost divided by the
change in Quantity
20. SHORT RUN COST TERMS
โข Economies of Scale
โข As total output increases,
average total cost
decreases
โข Diseconomies of
Scale
โข As total output increases,
average total cost
increases
21. SHORT RUN VERSUS THE LONG
RUN
โข Costs differ in the short run vs. the long run
โข Firms cannot adjust costs as quickly in the short run
โข Short run
โข Plant capacity is fixed
โข Difficult for businesses to enter or leave the industry
โข Long run
โข Plant capacity is variable
โข Business can leave or enter the industry
22. SHORT RUN AND LONG RUN
ADJUSTMENTS
โขShort Run adjustment
โขEX: Hire more workers
โขLong Run adjustment
โขEX: Build a new production facility
25. GRAPH AND LABEL THE
FOLLOWING:
โข Total fixed cost
โข Total variable cost
โข Total cost
โข Economies and Diseconomies of Scale
โข Average fixed cost
โข Average variable cost
โข Average total cost
โข Marginal cost
