The Costs of Production • Explicit and Implicit Costs – Explicit Costs: Money payments that a firm makes for the use of resources owned by others (labor, materials, fuel, etc.) – Implicit Costs: The opportunity costs of self-owned resources. The value of the next best thing you could do with your labor, time, tools, entrepreneurial talent, etc. Things you could have gotten paid to do.
The Costs of Production Explicit and Implicit Costs – Explicit Costs: Money payments that a firm makes for the use of resources owned by others (labor,
Dec 28, 2015
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The Costs of Production
• Explicit and Implicit Costs– Explicit Costs: Money payments that a firm makes
for the use of resources owned by others (labor, materials, fuel, etc.)
– Implicit Costs: The opportunity costs of self-owned resources. The value of the next best thing you could do with your labor, time, tools, entrepreneurial talent, etc. Things you could have gotten paid to do.
Walt and Jesse make peanut brittle in their lab.Explicit Costs: the equipment, electricity, the
ingredients, rent for the building, transportation to ship the product, etc.
Implicit Costs: all the money they could have made cooking something else in the lab.
Accounting Profit, Normal Profit, and Economic Profit
Accounting Profit – Business makes enough to cover its explicit costs. Any more is accounting profit.
Normal Profit – business makes enough to cover its explicit costs plus implicit costs, including enough to pay the entrepreneur an amount equal to what he or she could make running a business of a similar scope.
Economic Profit – profit over and above normal profit. It is an added reward to the entrepreneur and what lures new companies into an industry.
Jesse: “This is awesome, Mr. White. We spent $2000 on ingredients and materials, $10,000 to rent the lab and equipment for the month. We sold our peanut brittle for $20,000. That’s an $8000 profit!”
Walt: “Jesse you’re an idiot!!! …”
Short Run vs. Long Run
• Short run: To little time for a firm to change its plant capacity, but enough to change production levels by varying the amounts of resources (material, labor, etc.).
• Long Run: Enough time for a firm to alter plant capacity. For an industry, it’s also enough time for new firms to enter the business or existing firms to exit.
• Short run = Fixed Plant• Long Run = Variable Plant
Short-Run Production Relationships
• Total Product (TP) – Total quantity produced.• Marginal Product (MP) – The extra output
achieved by adding one more unit of some variable resource (one more worker, one more bag of peanuts, one more barrel of molasses)
• Average Product (AP) – Output per unit of labor.– So if we have 20 employees and produce 100 tons of
peanut brittle, our average output is 5 tons.
The Law of Diminishing Returns
TP
MP
AP
IncreasingMarginalReturns
DiminishingMarginalReturns
NegativeMarginalReturns
1 2 3 4 5 6 7 8 90
10
20
30To
tal p
rodu
ct, T
P
1 2 3 4 5 6 7 8 9
20
10
Mar
gina
l pro
duct
, MP
LO2
Law of Diminishing Returns
• As more and more variable resources are added, additional production gains will eventually decline.
Homework
• Do Ch. 22 Study Questions #1, 2, & 3.• Read p. 398 – 403 (stop at “Long-Run
Production Costs)– Do the quick quiz on 401 and check answers.– Explain IN YOUR OWN WORDS why the marginal cost
curve intersects the AVC and ATC curves at their minimum points. This is a key idea. Spend some serious time trying to wrap your head around this if you don’t get it at first.
– Do Study Questions 4 (complete the table and graph only), 6, and 7a.
0 1 2 3 4 5 6 7 8 9 10 11 12
30
20
10# of
Law
ns C
ut/D
ay
1 2 3 4 5 6 7 8 9 10 11 12
0
7
-3
Total Product
Marginal Product
Average Product
Quantity of Labor (# of workers)
Area of increasing marginal returns.
Area of decreasing marginal returns.
Area of negative marginal returns.
550
500
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200
150
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50
0 1 2 3 4 5 6 7 8 9 10
Total Cost
Total Variable Cost
Total Fixed Cost
550
500
450
400
350
300
250
200
150
100
50
0 1 2 3 4 5 6 7 8 9 10
A
B
C
Quantity (units)
Cost
($)
550
500
450
400
350
300
250
150
100
50
0 1 2 3 4 5 6 7 8 9 10
Total Cost
Quantity (units)
Cost
($)
200
105
100
90
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30
20
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0 1 2 3 4 5 6 7 8 9 10
Quantity (units)
Cost
($)
ATC1
ATC2
MC2
MC1
105
100
90
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60
50
40
30
20
10
0 1 2 3 4 5 6 7 8 9 10
Quantity (units)
Cost
($)
AVC1
?
AVC2
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