Businesses and the Costs of Production

Economic Costs

• Economic Cost: The payment necessary to obtain and retain resources.
  • Explicit Costs: Direct monetary payments.
  • Implicit Costs: Opportunity costs associated with self-owned resources, includes normal profit.

Profit Types

• Accounting Profit:
  • Formula: Accounting\, Profit = Revenue - Explicit\, Costs
• Economic Profit:
  • Definition: Accounts for both explicit and implicit costs.
  • Formula: Economic\, Profit = Accounting\, Profit - Implicit\, Costs
  • Simplified: Economic\, Profit = Revenue - Economic\, Costs
  • Where economic costs include both explicit and implicit costs.

Short Run vs Long Run

• Short Run:
  • Some inputs are variable, while others are fixed (fixed plant).
• Long Run:
  • All inputs are variable, firms can adjust plant size and can enter or exit industries.

Production Relationships

• Total Product (TP): Total output produced.
• Marginal Product (MP): Change in Total Product per unit increase in Labor Input.
  • Formula: MP = \frac{Change\, in\, Total\, Product}{Change\, in\, Labor\, Input}
• Average Product (AP): Output per unit of Labor.
  • Formula: AP = \frac{Total\, Product}{Units\, of\, Labor}

Law of Diminishing Returns

• Definition: As more variable resources are added to fixed resources of equal quality and unchanged technology, the marginal product will eventually decline.

Short-Run Production Costs

• Fixed Costs (TFC): Costs that do not change with output.
• Variable Costs (TVC): Costs that vary directly with output.
• Total Costs (TC): Sum of fixed and variable costs.
  • Formula: TC = TFC + TVC
• Average Costs: Per-unit costs calculated from total costs.
  • Average Fixed Cost (AFC): AFC = \frac{TFC}{Q}
  • Average Variable Cost (AVC): AVC = \frac{TVC}{Q}
  • Average Total Cost (ATC): ATC = \frac{TC}{Q}
  • Marginal Cost (MC): Change in total cost per unit output.
  • Formula: MC = \frac{\Delta TC}{\Delta Q}

Long-Run Production Costs

• Long-Run ATC: Average costs when all inputs can be varied, key for analyzing firm size and cost structures.
• Economies of Scale: Benefits from increased production, including:
  • Labor specialization.
  • Managerial specialization.
  • Efficient capital usage.
• Diseconomies of Scale: Inefficiencies that can arise in larger organizations, such as:
  • Coordination problems.
  • Communication issues.
  • Worker alienation.

Minimum Efficient Scale (MES)

• Definition: The lowest output level where long-run average costs are minimized.
  • Significance for industry structure: can indicate natural monopolies where one firm can supply the entire market efficiently.

Applications and Illustrations of Cost Principles

• Situations demonstrating real-world applications of economic costs and production relationships include varying sectors like gasoline pricing and manufacturing environments.

Conclusion on Industrial Evolution

• Recognition of the ongoing industrial evolution:
  • First Industrial Revolution: Mass production.
  • Second Industrial Revolution: Mass sales critical for R&D.
  • Current Technological Revolution: Emphasizing affordable mass customization.