Unit 5 - Cost Functions

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Unit 5 - Cost Functions. Explicit Costs and Implicit Costs Explicit cost are out-of-pocket expenses, such as labor, raw materials, and rent. Implicit costs are foregone expenses, such as the value of your own time, and the value of your own money (interest earned). Microeconomics.

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## Unit 5 - Cost Functions

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Unit 5 - Cost Functions
• Explicit Costs and Implicit Costs

Explicit cost are out-of-pocket expenses, such as labor, raw materials,and rent.

Implicit costs are foregone expenses, such as the value of your own time, and the value of your own money (interest earned).

Microeconomics

Which of the following comes closest to the true economic cost (on average) of earning a bachelor’s degree in college?
• \$10,000
• \$20,000
• \$40,000
• \$60,000
• \$160,000

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Unit 5 - Cost Functions

Estimated explicit costs of attending college (4 years):

tuition, fees, books, and transportation: \$15,000 x 4 = \$60,000 .Estimated implicit costs include foregone earnings, and foregone interest:\$25,000 x 4 = \$100,000.

Total economic cost: \$160,000.

Microeconomics

Unit 5 - Cost Functions
• Economic versus Accounting ProfitsEconomic profits equal total revenue minus all (explicit and implicit) costs.Accounting profits equal total revenue minus explicit costs.

Microeconomics

If a firm’s total revenue is \$80,000, and its explicit and implicit costs are \$50,000 and \$25,000, respectively, then its economic and accounting profits are:

• \$5,000; \$25,000
• \$5,000; \$30,000
• \$30,000; 5,000
• \$30,000; \$25,000
• \$75,000; \$80,000
Unit 5 - Cost Functions
• Economic versus Accounting Profits

Calculations

Economic Profit = \$80,000 - \$75,000

= \$5,000

Accounting Profit = \$80,000 - \$50,000

= \$30,000

Microeconomics

Unit 5 - Cost Functions
• Economic versus Accounting Profits Example 2:If a firm’s total revenue is \$80,000, and its explicit and implicit costs are \$70,000 and \$25,000, respectively, what are its economic and accounting profits?

Microeconomics

Unit 5 - Cost Functions
• Economic versus Accounting Profits

Economic Profit = \$80,000 - \$95,000

= - \$15,000

Accounting Profit = \$80,000 - \$70,000

= \$10,000From a financial point of view, should the firm continue to operate?

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Total and per unit economic costs include:

• Total Variable Cost (TVC)
• Total Fixed Cost (TFC)
• Total Cost (TC)
• Average Variable Cost (AVC)
• Average Fixed Cost (AFC)
• Average Total Cost (ATC)
• Marginal Cost (MC)

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Example 1If TVC + TFC = TC, and TVC and TFC are \$900 and \$300, respectively, what is TC?

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Total Variable Cost \$900

Total Fixed Cost \$300 + +

Total Cost \$1200

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Example 2If TC is \$1,200 and production is 50, what is ATC?

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

TC

\$1200

\$24

=

=

Q

50

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Example 3If production is 50, and total variable and total fixed cost are \$900 and \$300, respectively, what are average variable cost and average fixed cost? (Output = 50).

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Average variable cost =

Average fixed cost =

\$900

=\$18

50

\$300

=\$6

50

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Example 4Using the data in the previous examples, let’s say that you produce an additional 5 products, and your total cost rises to \$1260, what is your marginal cost?

Microeconomics

Unit 5 - Cost Functions
• Total and Per Unit Costs

Marginal cost =

change in total cost

\$60

=

= \$12

change in production

5

Microeconomics

Unit 5 - Cost Functions
• Cost CalculationsExample 5 - Fill in the missing values

Microeconomics

Unit 5 - Cost Functions
• Short-run Cost CalculationsExample 5 answer

Microeconomics

Unit 5 - Cost Functions
• The Shape of Typical Cost Curves

Costsin Dollars

MC

ATC

AVC

Quantity Produced

Unit 5 - Cost Functions
• The Long-run Average Cost CurveIn the long run, all inputs are variable. A firm has enough time to choose the size of its factory, farm, office building, or other capital goods.The firm can choose from many short-run cost curves. The bottom points of the short-run average cost curves make up the long-run average cost curve.

Microeconomics

Unit 5 - Cost Functions
• The Long-run Average Cost Curve

Long-run average costs fall as production first rises.

This is called economies of scale (EOS).

When the firm gets too big, long-run average costs

rise. This is called diseconomies of scale (DOS).

Average Costs

EOS

DOS

Quantity Produced

Microeconomics

Unit 5 - Cost Functions
• Returns to Scale

When inputs increase, and production more than proportionately increases, then we speak of increasing returns to scale (associated with economies of scale).

ExampleInputs increase by 10%, and production increases by 20%.

Microeconomics

Unit 5 - Cost Functions
• Returns to Scale

When inputs increase, and production less than proportionately increases, then we speak of decreasing returns to scale (associated with diseconomies of scale).

ExampleInputs increase by 10%, and production increases by 5%.

Microeconomics

Unit 5 - Cost Functions
• Returns to Scale

When inputs increase, and production increases by the same percentage, then we speak of constant returns to scale.

ExampleInputs increase by 10%, and production increases by 10%.

Microeconomics