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Chap007 (1)
This document discusses the economic costs of production for businesses. It defines explicit costs as monetary payments and implicit costs as the value of the next best use of self-owned resources, which together make up total economic costs. Accounting profit only considers explicit costs, while economic profit subtracts both explicit and implicit costs from total revenue. The document also covers short-run and long-run production relationships, costs, and curves, explaining how costs change based on variable and fixed inputs over time. In the long run, all inputs are variable and economies and diseconomies of scale can impact average total costs.
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Chap007 (1)
- 1. Businesses and theCosts of Production 07 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
- 2. Economic Costs • Thepayment that must be made to obtain and retain the services of a resource • Explicit Costs •Monetary payments • Implicit Costs •Value of next best use •Self-owned resources •Includes normal profit LO1 7-2
- 3. Accounting Profit andNormal Profit • Accounting profit = Revenue – Explicit Costs • Economic profit = Accounting Profit – Implicit Costs • Economic profit (to summarize) =Total Revenue – Economic Costs =Total Revenue – Explicit Costs – Implicit Costs LO1 7-3
- 4. Economic Profit LO1 Explicit costs Accounting costs (explicit costsonly) Implicit costs (including a normal profit) Economic profit Accounting profit Economic (Opportunity) Costs TotalRevenue 7-4
- 5. Short Run andLong Run • Short Run •Some variable inputs •Fixed plant • Long Run •All inputs are variable •Variable plant •Firms enter and exit LO1 7-5
- 6. Short-Run Production Relationships •Total Product (TP) • Marginal Product (MP) • Average Product (AP) LO2 Marginal Product Change in Total Product Change in Labor Input= Average Product Total Product Units of Labor = 7-6
- 7. The Law ofDiminishing Returns LO2 TP MP AP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 1 2 3 4 5 6 7 8 9 0 10 20 30 TotalProduct,TP 1 2 3 4 5 6 7 8 9 20 10 MarginalProduct,MP 7-7
- 8. Short-Run Production Costs •Fixed Costs (TFC) •Costs do not vary with output • Variable Costs (TVC) •Costs vary with output • Total Costs (TC) •Sum of TFC and TVC •TC = TFC + TVC LO3 7-8
- 9. Short-Run Production Costs LO3 Costs 12 3 4 5 6 7 8 9 100 Q 100 200 300 400 500 600 700 800 900 1000 $1100 TFC TC TVC Total Cost Variable Cost Fixed Cost 7-9
- 10. Per-Unit, or Average,Costs • Average Fixed Costs AFC = TFC/Q • Average Variable Costs AVC = TVC/Q • Average Total Costs ATC = TC/Q • Marginal Costs MC = ΔTC/ΔQ LO3 7-10
- 11. Per-Unit, or Average,Costs LO3 Costs 1 2 3 4 5 6 7 8 9 100 Q 50 100 150 $200 AFC ATC AVC AVC AFC 7-11
- 12. Marginal Cost LO3 Costs 1 23 4 5 6 7 8 9 100 Q 50 100 150 $200 AFC MC ATC AVC AVC AFC 7-12
- 13. MC and MarginalProduct LO3 MP AP MC AVC Quantity of Output Quantity of Labor Production Curves Cost Curves 7-13
- 14. Long-Run Production Costs •The firm can change all input amounts, including plant size. • All costs are variable in the long run. • Long run ATC •Different short run ATCs LO4 7-14
- 15. The Long-Run CostCurve LO4 Long-Run ATC AverageTotalCosts ATC-1 ATC-2 ATC-3 ATC-4 ATC-5 Output 7-15
- 16. Economies and Diseconomiesof Scale • Economies of scale •Labor specialization •Managerial specialization •Efficient capital •Other factors • Constant returns to scale LO4 7-16
- 17. Economies and Diseconomiesof Scale • Diseconomies of scale •Control and coordination problems •Communication problems •Worker alienation •Shirking LO4 7-17
- 18. MES and IndustryStructure • Minimum Efficient Scale (MES): •Lowest level of output where long- run average costs are minimized •Can determine the structure of the industry LO4 7-18
- 19. MES and IndustryStructure LO4 Output AverageTotalCosts Long-Run ATC Economies Of Scale Constant Returns To Scale Diseconomies Of Scale q1 q2 7-19
- 20. Don’t Cry OverSunk Costs • Sunk costs •Costs have already been incurred and thus are irrecoverable • Rule: Do not engage in any activity where MB<MC • Rule: Ignore sunk costs •They are irrecoverable 7-20