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Profit = Total Revenue Total Costs Total Net Benefits = Total Benefits minus Total Costs Costs as Opportunity Costs
Explicit Costs Implicit Costs
Opportunity cost of entrepreneurs invested capital Opportunity cost of entrepreneurs time
Economic versus Accounting Profit Normal Profits: the accounting profits that just covers implicit or opportunity costs
Economic profit Accounting profit Revenue Implicit costs Total opportunity costs Revenue
Explicit costs
Explicit costs
Technology is the state of knowledge about how to combine inputs to produce output. Production Function describes the relationship between inputs and outputs
Q = F ( K, L , NR, E)
Remember the widget example! Applying more labor resulting in a diminishing marginal product of labor and increasing marginal costs. Lets see this at work again in a more detailed way.
Production function
Table 1 A Production Function and Total Cost: Hungry Helens Cookie Factory
Copyright2004 South-Western
Marginal Cost (MC) = change in TC/ change in Q and measures the cost of producing another unit. (general formula) Average Cost (AC) = TC/Q and measures the cost of a typical unit of output.
Cost Formulas
TC = FC +VC Dividing both sides of the total cost formula by Q, we get the average cost formula:
TC/Q = FC/Q + VC/Q ATC = AFC +AVC Average Total Cost = Average Fixed Cost + Average Variable Cost
Fixed Quantity Cost 0 1 2 3 4 5 6 7 8 9 10 $ $ $ $ $ $ $ $ $ $ $ 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00
Marginal Costs
$ $ $ $ $ $ $ $ $ $
0.30 0.80 1.50 2.40 3.50 4.80 6.30 8.00 9.90 12.0
$ 3.30 $ 3.80 $ 4.50 $ 5.40 $ 6.50 $ 7.80 $ 9.30 $ 11.00 $ 12.90 $ 15.00
$ $ $ $ $ $ $ $ $ $
0.30 0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90 2.10
Quantity AFC 0 1 2 3 4 5 6 7 8 9 10
AVC
ATC
MC
$ $ $ $ $ $ $ $ $ $
3.00 1.50 1.00 0.75 0.60 0.50 0.43 0.38 0.33 0.30
$ $ $ $ $ $ $ $ $ $
0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 1.10 1.20
$ $ $ $ $ $ $ $ $ $
3.30 1.90 1.50 1.35 1.30 1.30 1.33 1.38 1.43 1.50
$ $ $ $ $ $ $ $ $ $
0.30 0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90 2.10
MC
ATC AVC
LR cost curves are U-shaped if a production process is characterized by first by economies of scale, and then diseconomies of scale. Since capital can be varied, the long-run cost curves describe the costs with changing the scale of operations (reducing or increasing plant size).
The long-run cost curve is constructed from various short-run cost curves.
Remember increasing capital makes labor more productive, so increase plant size makes labor more productive and decreases marginal costs Even though marginal costs decline, average costs may go up or down because of the cost of capital and labor are added together to calculate average costs.
ATC in short ATC in short run with run with medium factory large factory
$12,000
1,200
ATC in short ATC in short run with run with medium factory large factory
1,000 1,200
Summary
Short-run at least one input is fixed so the primary decision is how best to use existing plant capacity Long-run all inputs are variable so the primary decision is what overall scale of operations or plant size should be chosen.