ECON 102 Chapter 7 Slides

Chapter 7: Production and Costs

Firm Definition

• Firms: Economic institutions that transform resources (factors of production) into outputs.

• Key Decisions for Firms:

  • What consumers will purchase.

  • How to produce goods or services.

Types of Firms

• Sole Proprietorships:

  • One owner.

  • Easy to start.

  • Limited access to financial capital.

  • Owner's personal assets subject to unlimited liability.

• Partnerships:

  • More than one owner.

  • Task division among partners.

  • Personal assets of all owners subject to unlimited liability.

  • Includes negligence by partners.

• Corporations:

  • Owners called shareholders.

  • Have legal rights akin to individuals.

  • Raise funds via issuing stocks/bonds.

  • Owners protected by limited liability.

  • Losses limited to the value of stock.

Business Goals

• The primary goal of businesses is to maximize profit:

  • Profit = Total Revenue - Total Costs (TR - TC)

Economic Costs

Types of Costs

• Explicit Costs:

  • Direct payments to another entity (e.g., wages, lease payments).

• Implicit Costs:

  • Opportunity costs of resources used in business, not directly paid out.

• Accounting Profit:

  • Total Revenue - Explicit Costs

• Economic Profit:

  • Total Revenue - Explicit Costs - Implicit Costs

Example: Bubble Tea Shop

• Accounting Revenue: $120,000

• Explicit Costs: $100,000

• Implicit Costs (time): $40,000; (savings): $10,000

• Total Cost: $150,000

• Profit: +$20,000 (Accounting), –$30,000 (Economic)

Production Concepts

Profit Types

• Economic Profit: Greater than zero after considering implicit costs.

• Normal Profit: Economic profit equals zero.

Production Process

• Marginal Product: Change in output due to a change in labor (ΔQ / ΔL).

  • Initially rises, then falls due to diminishing returns.

• Average Product: Total output divided by total labor input (Q / L).

Short-Run Production

Key Points

• Marginal Cost: Change in total cost due to the production of one more unit (MC = ΔTC / ΔQ).

• Average Cost: Measured productivity in terms of cost efficiency.

  • Average Fixed Cost = FC / Q

  • Average Variable Cost = VC / Q

  • Average Total Cost = TC / Q

Cost Concepts

• Fixed Costs: Do not change with output.

• Variable Costs: Increase with output.

• Sunk Costs: Already incurred and cannot be recovered; rational decisions ignore these.

Long-Run Cost Analysis

Cost Dynamics

• Economies of Scale:

  • As output increases, long-run average total costs decrease.

  • Resulting from specialization, better capital use, and complementary techniques.

• Diseconomies of Scale:

  • Average total costs rise as firms grow larger due to bureaucracy, increased costs of scarce resources, and operational challenges.

Returns to Scale

• Average long-run costs vary with output:

  • Economies of Scale → Constant Returns → Diseconomies of Scale.

Practice Questions

• Marginal Cost of bakery for 100 cupcakes: (Cost of 200 cupcakes - Cost of 100 cupcakes) / 100 = Marginal Cost

• Identify explicit costs:

  • Example of explicit cost: Raw materials.

• Fixed Cost Examples:

  • Lease on a building.