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 BASIC ELEMENTS of Capital

• Capital goods, such as machines and

tools, are used in the production of
other goods. Companies acquire
capital to begin or expand production
or to become more productive. The
term capital stock denotes all that is
needed to produce goods. Labor skills
are referred to as human capital.
 Explicit & Implicit Costs

• A Firm’s costs of Production include

the Explicit & Implicit costs.
1. Explicit Cost. Involves a direct money
outlay for factors of production.
2. Implicit Cost. Do not involve a direct
money outlay.
• Explicit Costs are monetary payments
a firm makes to an outsider to obtain
a resource. “out of pocket expenses.”
• Implicit costs are the monetary
income a firm sacrifices when it uses
resources it owns rather than
supplying the resources on the open
market. “alternative uses”
Normal profits are an implicit cost.
• Cost of Production = Explicit + Implicit
Costs
• Economic Profit as differed from
Accounting Profit
1. Accounting Profit = Total Revenue -
Explicit Costs
2. Economic profit = total revenue - all
costs
• When total revenue is greater than all
costs, the entrepreneur has an economic,
or pure, profit.
 Short Run vs. Long Run
• Short Run
– fixed plant - too brief to change plant capacity
– input of certain resources (labor, materials)
may be changed in order to alter output
– ex. – UST hires 100 extra workers to work at
the newly constructed parking area.
• Long Run
– variable plant - plant capacity may be changed
– firms may enter or exit the market
– ex. UST puts up a branch in Sri Lanka
 Law of Diminishing Returns
• Reflected in “short run” production.
• As successive increments of a variable
resource are added to a fixed resource, the
marginal product (MP) of the variable
resource will eventually decrease.
• Assumption - units of variable resource
are of equal quality
Example - Factory overcrowding
 Short Run Production
Relationships
• Total Product (TP) = total output of a
particular good or service produced by a
firm
• Marginal Product (MP) = the additional
output produced when an additional unit
of a resource is employed
• Average Product (AP) = the total output
produced per unit of a resource employed
 Total Product

• Total Product declines at the point

where additional units of labor ( a
variable resource) become inefficient
in their use of a fixed resource.
• Total Product declines when marginal
product becomes negative.