Review note

Production and Costs

Abstract

This lecture note will review some basic but important concepts about produc-
tion and csots covered by Chapter 14 in the textbook.

Accounting Profit and Economic Profit

(a)
Accounting Profit = Total Revenue − Accounting Costs

(b)

Economic Profit, π = Total Revenue − Opportunity Costs

= Total Revenue − (Explicit Costs + Implicit Costs)

= Accounting Profit − Implicit Costs

(c)
π > 0 (excess profit) → Accounting profit > Implicit Costs
π = 0 (normal profit) → Accounting profit = Implicit Costs
π < 0 (economics loss) → Accounting profit < Implicit Costs

Short run and Long run cost

Definition 0.1 The short run is the time frame in which the quantities of some resources
are fixed(at least one resource). The long run is the time frame in which the quantities of
all resources can be varied.

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Short run Costs

(a)
TC = TV C + TFC

(b)
AT C = AV C + AF C

(c)
TC
AT C =
Q

(d)
∂T C ∂T V C
MC = =
∂Q ∂Q

(e)
TV C
AV C =
Q

(f)
TFC
AF C =
Q

Note:

(a) As long as the TFC exist in the cost function, it means that is short run. Because
all factors can be varied in the long run, we won’t see any fixed cost in the cost
function.

(b) MC will pass through the minimum point of AC and AVC.

Production The production function is T P = Q(L, K).

(a)
TP
AP =
Q

(b)
∂T P
MP =
∂Q

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 (c) MP will pass through the maximum point of AP

1. Karen works part-time at a local convenience store and earns $10 per hour. She want
to spend next Saturday afternoon attending a music concert. The full price of a concert
ticket is $75, but Karen was able to get a discounted price of $50 from a friend who
purchased the ticket but has become unable to attend. If Karen took 4 hours off from her
job to attend the concert, what was her opportunity cost of attending the concert?
Opportunity cost = Explicit costs + Implicit costs = 50 + 4 × 10 = 90

2. Joe is self-employed in a store that has a rental value of $500 a month which he pays,
but he can vacate the building without giving notice. His other expenses are $100 a month
for maintenance. He makes $25, 000 a year on net sales(total revenue minus the wholesale
cost of the product). If he quit his job and worked the same number of hours else where
at a job he liked equally well, he estimates that he could make $20, 000 a year. Suppose
that the store owner gave Joe the store. Now what should he do?
Job 1:
Accounting profit: 25, 000 − 12 ∗ 100 = 23, 800
Economic profit: 25, 000 − 12(500 + 100) − 20, 000 = −2, 200
Job 2:
Accounting profit: 20, 000
Economic profit: 20, 000 − 17, 800 = 2, 200.
Joe should choose Job 2.

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