Costs of Production

Costs of Production

Reminders

  • Exam 2 is in one week on Thursday, April 3rd, covering chapters 6, 7, 8, and 9.
  • Review day is Tuesday, April 1st.
  • Quizzes for chapters 8 and 9 are available.
  • Chapter 13 will be covered today but is not part of Exam 2; it will be on Exam 3 during finals week.

Chapter Overview

  • This chapter is considered a little intense and potentially boring, although many business students find it interesting.
  • The chapter includes numerous graphs.
  • Understanding the underlying principles is crucial, even though findings will be summarized.
  • This chapter is fundamental for understanding chapters 14 and 15.

What are Costs?

  • Total Revenue: The amount a firm receives from the sale of its output.
  • Total Cost: The market value of the inputs a firm uses in production.
  • Profit: Total revenue minus total cost.

Explicit vs. Implicit Costs

  • Explicit Costs: Input costs that require a direct monetary outlay by the firm.
    • Examples: Payments to workers, for capital, and for land.
  • Implicit Costs: Input costs that do not require a direct monetary outlay by the firm.
    • Examples: Opportunity costs of time or money, often ignored by accountants.
  • Total Costs: The sum of explicit and implicit costs.

Economic Profit vs. Accounting Profit

  • Economic Profit: Total revenue minus total cost (including both explicit and implicit costs).
  • Accounting Profit: Total revenue minus total explicit costs.

Economists vs. Accountants

  • Economists consider all opportunity costs (both explicit and implicit) when analyzing a firm.
  • Accountants only measure explicit costs.
  • Therefore, economic profit is typically smaller than accounting profit.

Clicker Question: Jacqui's Business

  • Jacqui earns $50,000 in accounting profit in her first year of business.
  • She turned down job offers with annual salaries of $30,000, $40,000, and $45,000.
  • To calculate Jacqui's economic profit, we subtract the highest salary she turned down (opportunity cost) from her accounting profit: $50,000 - $45,000 = $5,000.
  • Therefore, Jacqui's economic profit is $5,000.

Production Function and Marginal Product

  • Production Function: The relationship between the quantity of inputs used to produce a good and the quantity of output of that good.
  • Marginal Product: The increase in output that arises from an additional unit of input.

Fixed vs. Variable Costs

  • Fixed Costs: Costs that do not vary with the quantity of output produced.
  • Variable Costs: Costs that vary with the quantity of output produced.
  • Total Cost: Fixed cost plus variable cost.
  • Total-Cost Curve: Shows the relationship between the quantity produced and total costs.

Production and Costs Relationship

  • At low levels of production, marginal product (MP) is typically high because few people have access to many machines, making each worker highly productive.
  • Law of Diminishing Returns: As more inputs are added, at some point, it becomes less effective to hire more people, and the MP diminishes as the number of inputs increases, leading to a