Costs of ProductionMr. 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;

Economic costs are the payments to obtain and retain the services of a resource;

Explicit vs. Implicit Costs Explicitcost of resources outside what is already owned; Implicitcost 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 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 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 – 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 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 Extra output associated with added input (such as labor); = Change in total product/change in labor input

Average Product (aka labor productivity) Output per unit of labor input; =total product/units of labor;

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;

Total Product, Average Product, and Marginal Product Graphs Draw and label the graphs. What does each graph tell us about production? What is the

purpose of the graphs? Explain to the side of each graph WHY the lines increase

when they do or decrease when they do. WHY does the MP line intersect the AP line where it does?

Explain that point.

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 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… 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 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 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 Allows sufficient time for new firms to enter and old to exit;

can also change ALL inputs used;

Determinants of the Economies of Scale/LRATC Labor Specialization – Jobs can be divided and subdivided

for efficiency Managerial Specialization – managers can now operate to

their capacity Efficient Capital – larger firms and industries have the ability

to incorporate the more efficient capital; Start up Costs – costs that will decrease per unit as output

rises

Diseconomies of Scale Major determinant is the inability to control and coordinate

the firms operations as they become such a large scale producer.

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?