Lecture microeconomics chapter 6 cost of production

HUTECH Institute of International Education Cost of production COST OF PRODUCTION 6 1 WHAT ARE COSTS? 6 2 PRODUCTION AND COSTS 6 3 VARIOUS MEASURE OF COSTS 6 4 COST IN SHORT RUN AND LONG RUN HUTECH In[.]

COST OF PRODUCTION

6.1 WHAT ARE COSTS?

6.2 PRODUCTION AND COSTS

6.3 VARIOUS MEASURE OF COSTS

6.4 COST IN SHORT-RUN AND LONG-RUN

Total Revenue, Total Cost, Profit

▪ Assume that the firm’s goal is to maximize profit.

the amount a firm receives from the sale of its output

the market value

of the inputs a firm uses in production

Costs: Explicit vs Implicit

▪ Explicit costs require an outlay of money, which are actually paid by the firm

e.g., paying wages to workers, lease payment,

cost of raw materials…

▪ Implicit costs opportunity costs of resources

owned and used by the firm but not actually paid for by the firm

e.g. , opportunity cost of the owner’s time or labor,

▪ Both matter for firms’ decisions.

Explicit vs Implicit Costs: An Example

You need $100,000 to start your business, i=5%

▪ Case 1: borrow $100,000

▪ explicit cost = $5000 interest on loan

▪ Case 2: use $40,000 of your savings,

borrow the other $60,000

▪ explicit cost = $3000 (5%) interest on the loan

▪ implicit cost = $2000 (5%) foregone interest you

could have earned on your $40,000.

In both cases, total (explicit + implicit) costs are $5000.

Economic Profit vs Accounting Profit

▪ Accounting profit

= total revenue minus total explicit costs

▪ Economic profit

= total revenue minus total costs (including explicit and implicit costs)

▪ Accounting profit ignores implicit costs,

so it’s higher than economic profit

Profit Example

Suppose an individual runs his own business with the following revenue and costs for the year:

• Sales Revenue: $800,000

• Cost of Materials, Rent and Labour: $750,000

• Salary Foregone: $60,000 (opportunity cost)

Calculate:

Accounting Profit ?

Economic Profit ?

Profit Example

Accounting Profit?

= $50,000 (= $800,000 - $750,000)

Economic Profit?

= $800,000 - $750,000 - $60,000 = -$10,000

(=.= He made an economic loss)

Summary of Cost and Profit

Economic profits

Implicit costs (including a normal profit)

Explicit Costs

Accounting costs (explicit costs only)

Accounting profits

Total Revenue

Profits to an economist

Profits to an accountant

The Production Function

▪ A production function shows the relationship between the quantity of inputs used to produce

a good and the quantity of output of that good.

▪ It can be represented by a table, equation, or graph.

▪ Example 1:

• Farmer Jack grows wheat.

• Analysis in short run

0 500 1,000 1,500 2,000 2,500 3,000

0 1 2 3 4 5

3000 5

2800 4

2400 3

1800 2

1000 1

0 0

Q

(bushels

of wheat)

L

(no of

workers)