eFarmer.us
Explicit costs - requires an outlay of money,
payment to non owners for resources:
― paying wages
― paying rent
― paying interest
Implicit costs - doesn’t require a cash outlay,
opportunity cost:
― the owner’s time
lost wages
― the owner’s property forgone rental income
― the owner’s money
forgone interest income
eFarmer.us
Shoe Co.
Revenue
Worker Wages
Rent Expense
Leather Cost
Explicit Cost
Accounting Profit
Principal
Superintendent
Teacher
$300,000
$100,000
$50,000
$100,000
$250,000
$50,000
$100,000
$50,000
$30,000
Economic Loss
Profit
- $20,000
$50,000
$0
Explicit
Explicit
Explicit
Implicit
Accounting profit - total revenue minus total explicit costs
Economic profit - total revenue minus total costs (includes explicit
and implicit costs)
Accounting profit ignores implicit costs and it’s always higher than
economic profit.
eFarmer.us
Short Run is a time period so short at least one input is fixed
Cost for a fixed input is termed Fixed Cost
― Factory
― Special equipment
― Land
Long Run is a time period so long that all inputs can change
Firms can build more factories or sell existing ones
eFarmer.us Production Function - Hay
Production Function
shows the relationship between the level of inputs
used to produce output
― Labor to cars
― Water to hay
― Grass to beef
with at least one fixed input
the production function is a short run concept
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eFarmer.us Production Function - Hay
- A fixed resource
- Production efficiency
Tractor and Wagon
Implies Maximum Output per Worker
Hay per
Hour
𝑀𝑃 =
0
1
0
10
10
$8/10= 0.80
2
3
25
50
15
25
$8/15= 0.53
$8/25= 0.32
4
5
65
75
15
10
$8/15= 0.53
$8/10= 0.80
6
7
80
80
5
0
$8/5= 1.60
Labor
∆𝑄
∆𝐿
𝑀𝐶 =
𝑊𝑎𝑔𝑒
𝑀𝑃
Wage = $8
Marginal Product (MP): output produced by using one more variable input
Diminishing Marginal Product MP increasing at a decreasing rate
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eFarmer.us Production Function - Hay
Using the Hay example
$
MC
Minimum Marginal Cost
corresponds to maximum
Marginal Product
0.80
0.32
10 25 50 65 75
80
Hay
Hay
Hay
TP
50
25
Diminishing
Marginal Product
10
1
2
3
4
5
6
Workers
MP
1
2
3
4
5
6
Workers
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eFarmer.us Short Run
∆𝑇𝐶
𝑇𝐹𝐶
𝑇𝐶
𝑇𝑉𝐶
AF𝐶
AV𝐶
AT𝐶
=
𝑀𝐶 =
𝑄𝑄
∆𝑄
Cost of Production
- Fixed Cost (TFC)
- Variable Cost (TVC)
- Total Cost (TC)
- Marginal Cost (MC)
costs that don’t vary as output changes
costs that do vary as output changes
TC = TFC + TVC
the cost of producing one more output (Q)
Q
TFC
TVC
TC
0
1
2
3
4
5
6
7
8
9
$10
$10
$0
$4
$10
$10
$10
$10
$10
$10
$10
$10
MC
AFC
AVC
ATC
$10
$14
$4
--$10.00 $4.00
-$14.00
$7
$11
$18
$28
$17
$21
$28
$38
$3
$4
$7
$10
$5.00
$3.33
$2.50
$2.00
$3.50
$3.67
$4.50
$5.60
$8.50
$7.00
$7.00
$7.60
$47
$74
$112
$162
$57
$84
$122
$172
$19
$27
$38
$50
$1.67
$1.43
$1.25
$1.11
$7.83
$10.57
$14.00
$18.00
$9.50
$12.00
$15.25
$19.11
Copyright 2010 eStudy.us [email protected]
eFarmer.us Cost of Production
Calculation Equations
TC TC1  TC0
MC 

Q
Q1  Q0
at Q = 6
$57  $38 $19

 $19
65
1
TFC
Q
$10
 $1.67
6
TVC
AVC 
Q
$47
 $7.83
6
TC
ATC 
Q
$57
 $9.50
6
ATC  ATC  AFC
$7.83  $1.67  $9.50
AFC 
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eFarmer.us
Cost Curves
$
MC
$19.00
ATC
AVC
$1.67
AFC
$9.50
$7.83
1
2
3
4
5
6
7
8
9
Q
The MC curve intersects the ATC curve at minimum average total cost.
— when MC < ATC, ATC falls as Q rises
— when MC > ATC, ATC rises as Q rises
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eFarmer.us
Long Run Cost Curves
Owner’s can change any input, all costs are variable
Economies of
scale
Constant returns
to scale
$
Diseconomies of
scale
$
$
LRAC
LRAC
LRAC
Q
ATC falls
as Q increases
Telephone
Industry
Q
Q
ATC stays the same
as Q increases
Automotive
Industry
ATC rises
as Q increases
Diamond
Industry
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