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Costs of Production

Costs of Production. Mr. 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;

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Costs of Production

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  1. Costs of Production Mr. Bammel

  2. 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;

  3. Explicit vs. Implicit Costs • Explicitcost of resources outside what is already owned; • Implicitcost 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

  4. 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?

  5. 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;

  6. 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;

  7. 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

  8. Marginal Product • Extra output associated with added input (such as labor); • = Change in total product/change in labor input

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

  10. 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;

  11. 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?

  12. 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;

  13. 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;

  14. 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;

  15. 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?

  16. Long-Run Production Costs • Allows sufficient time for new firms to enter and old to exit; can also change ALL inputs used;

  17. 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?

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