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Costs of Production. Mr. Bammel. Economic Costs. Businesses have costs for the same reason that consumers do: Scarcity; Essentially the resources that businesses need in production have many alternative uses and we must allocate these resources in the most efficient way possible;

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economic costs
Economic Costs
  • Businesses have costs for the same reason that consumers do: Scarcity; Essentially the resources that businesses need in production have many alternative uses and we must allocate these resources in the most efficient way possible;
  • Economic costs are the payments to obtain and retain the services of a resource;
explicit vs implicit costs
Explicit vs. Implicit Costs
  • Explicitcost of resources outside what is already owned;
  • Implicitcost of using resources the business already owns rather than selling those resources elsewhere; Ex. Your wages you could have earned working elsewhere;
  • Economic Costs = Explicit + Implicit
accounting vs economic profits
Accounting vs. Economic Profits
  • Accounting profits only take into account your explicit costs: Accounting profits = Revenue – Explicit Costs
  • Economic Profits is the result of taking into account ALL costs: Economic Profits = Revenue – explicit costs – implicit costs;
  • Which do you suppose Economists focus on?
economic profits
Economic Profits
  • Why?
  • Allows us to see true allocation of resources; if a business is generating an economic loss, then we can shift resources to other firms which have economic gain;
  • Resources thus flow from producing goods and services with lower net benefits toward producing goods and services with high net benefits;
short vs long run
Short vs. Long Run
  • Short – period too brief to alter plant capacities; Plant is FIXED in short run;
  • Long – period long enough to alter ALL resources it employs, including plant capacities;
  • Keep in mind these are conceptual periods, not calendar;
production relationships
Production Relationships
  • Costs are dependent on the prices of resources and the quantity of resources (both are obviously defined by the Supply and Demand of resources) to produce output;
  • Total product – total quantity of good or service produced
marginal product
Marginal Product
  • Extra output associated with added input (such as labor);
  • = Change in total product/change in labor input
average product aka labor productivity
Average Product (aka labor productivity)
  • Output per unit of labor input;
  • =total product/units of labor;
law of diminishing returns
Law of Diminishing Returns
  • As successive units of a variable resource (ex. Labor) are added to fixed resources (ex. Capital or land) beyond a certain point the extra, or marginal, product that can be attributed to each additional unit of the variable resource will decline;
  • We can see the Law of diminishing returns in the Total Product, Average Product, and Marginal Products Curves;
comparing my graphs to yours
Comparing My Graphs to Yours
  • Are they drawn right?
  • Is everything neatly drawn and displayed?
  • Do you believe you explained the purpose of the graph correctly?
  • Did you explain the lines? Why increasing? Why decreasing? What are the intersecting points meaning?
short run production costs
Short-Run Production Costs
  • Fixed  costs that do NOT vary with output;
  • Variable  costs that do CHANGE with output;
  • Total  the sum of fixed and variable costs;

*very important to business managers b/c they can alter variable costs to change TC, but have no control over TFC;

other costs
Other costs…
  • Per unit, or Average, Cost: more meaningful to comparisons with product prices;
    • AFC = TFC/Q; will decrease as output increases;
    • AVC = TVC/Q; initially decreases, hits min., then increases (reflects law of diminishing returns);
    • ATC = TC/Q = TFC/Q + TVC/Q = AFC + AVC;
marginal costs
Marginal Costs
  • The extra/additional cost to produce one more unit of output;
  • MC = change in TC/change in Q;
  • By knowing MC, firms define cost incurred in producing the last unit; which also means they know what could have been “saved;”
  • When paired with MR, MC allows a firm to determine profitability of expanding or contracting decisions;
short run production costs graph
Short Run Production Costs Graph
  • Are they drawn right?
  • Is everything neatly drawn and displayed?
  • Do you believe you explained the purpose of the graph correctly?
  • Did you explain the lines? Why increasing? Why decreasing? What are the intersecting points meaning?
long run production costs
Long-Run Production Costs
  • Allows sufficient time for new firms to enter and old to exit; can also change ALL inputs used;
long run production costs graph
Long-Run Production Costs Graph
  • Are they drawn right?
  • Is everything neatly drawn and displayed?
  • Do you believe you explained the purpose of the graph correctly?
  • Did you explain the lines? Why increasing? Why decreasing? What are the intersecting points meaning?
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