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The Costs of Production

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.)

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The Costs of Production

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  1. 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.

  2. Walt and Jesse make peanut brittle in theirlab. Explicit Costs: the equipment, electricity, the ingredients, rent for the building, transportation to ship the product. Implicit Costs: all the money they could have made cooking something else in the lab.

  3. 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, includingenough 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.

  4. 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!!! …”

  5. 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

  6. 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 ton 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.

  7. Law of Diminishing Returns • As more and more variable resources are added, additional production gains will eventually decline.

  8. 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.

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