Powerpoint Chapter 9 - Businesses and the Costs of Production

Economic Cost

The payment that must be made to obtain and retain the services of a resource

Explicit Costs

Monetary outlay

Implicit costs

Opportunity cost of using self-owned resources. Includes a Normal Profit.

Accounting Profit

= Revenue - Explicit costs

Economic Profit

= Accounting profit - Implicit costs

Economic Profit (To summarize)

• = Revenue - Economic costs

• = Revenue - Explicit costs - Implicit costs

Implicit Costs

Include a normal profit

Economic Costs

are also called Opportunity Costs

Accounting Costs

are explicit costs only

Short Run

• Some variable inputs

• Fixed plant

Long Run

• All inputs are variable

• Firms can adjust plant size as well as enter and exit industry

Total Product (TP)

The total quantity that is produced.

Marginal Product (MP)

Amount that total product changes when labor changes by 1 unit

Marginal Product =

Change in total product / Change in labor input

Average Product (AP)

Output that is produced per unit of labor

Average Product =

Total product / Units of labor

Law of Diminishing Returns

• Resources are of equal quality

• Technology is fixed

• Variable resources are added to fixed resources

• At some point, marginal product will fall

Fixed Costs (TFC)

Costs that do not vary with output

Variable Costs (TVC)

Costs that do vary with input

Total Cost (TC)

• Sum of TFC and TVC

• TC = TFC + TVC

Average Fixed Cost (AFC) =

TFC / Q

Average Variable Cost (AVC) =

TVC / Q

Average Total Cost (ATC) =

TC / Q

Marginal Cost (MC) =

Change in TC / Change in Q

Long Run Production Costs

• The firm can change all input amounts, including plant size

• All costs are variable in the long run

Economies of Scale

• Labor specialization

• Managerial Specialization

• Efficient Capital

Constant Returns to Scale

Will occur when ATC is constant over a variety of plant sizes

Diseconomies of Scale

• Control and coordination problems

• Communication problems

• Worker alienation

• Shirking

Minimum Efficient Scale (MES)

• Lowest level of output at which long run average costs are minimized

• Can determine the structure of the industry

Natural Monopoly

Long run costs are minimized when only one firm produces the product