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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?