Chapter 22 ? The cost of production Economic (opportunity) costs include all payments that must be received by resource owners in this case the explicit and implicit costs. Explicit costs Flow to resources owned and supplied by others Implicit costs Payments for the use of self-owned and self-employed resources. Economic profit is less (minus) all explicit costs and implicit costs, including a normal profit) Economic Profit = Total Revenue ? Economic Cost Normal profit as a cost is the implicit cost of an entrepreneurial talent Accounting profit is equal to total revenue less (minus) accounting (explicit) cost. So, when an economist says a certain firm is earning only enough revenue to cover its costs, this means it is meeting all explicit and implicit costs and the entrepreneur is receiving a payment just enough to retain talents. Law of diminishing returns It?s what happens to output as a fixed plant. When a variable resource (labor) is added to a fixed resource (capital), marginal product associated with each additional unit of a resource declines. Because some resources are variable and others are fixed, costs can be classified as variable or fixed in the short run. Short run: A firm?s plant capacity is fixed Long run: A firm?s plant capacity is fixed; in the long run. A firm can vary its plant size and firms can enter or leave the industry. Total product (TP): total quantity/output, of a particular good produced Marginal product (MP): extra output associated with adding a unit of variable resource (labor) to the production process. MP = Change in total product Change in labor input Average product (AP): also called labor productivity. Output per unit of labor input AP = Total product Units of labor Fixed costs: independent of the level of output Variable costs: vary with the level of output. The total cost of any output is the SUM of fixed and variable cost of that output. Average fixed cost (AFC) AFC = TFC QAFC must decline as output increases Average variable cost (AVC) AVC = TVC Q Average variable cost is U-shaped Average total cost (ATC) ATC = TC = TFC + TVC = AFC + AVC Q Q Q Average total cost is U-shaped Marginal Cost (MC) MC = Change in TC Change in Q MC to AVC and ATC show that MC curve intersects both AVC and ATC curves at their minimum points. The relationship between productivity curves and cost curves is that MC and AVC cure in are mirror images of the MP and AP curves in. Fixed costs double from $100 to $200, AFC shifts upward. ATC shifts upward. AVC and MC curves UNALTER because their locations are based on the prices of variable rather than fixed resources. If the price of labor or some variable input rises, AVC, ATC, and MC rise and shift upward. AFC remains in place because fixed costs have not changed. 14. U-shaped long-run average-total-cost reflects economics and then diseconomies of scale. 15. Economics of scale *Downsloping part of the long-run ATC curve *Benefits you get from Mass production/ Specialization/ Efficient Capital *Reducing the unit cost as you produce more and more of the same thing Diseconomies of scale *Difficult to control and it?s not encountered until a considerably large scale of output has been achieved. *Encountering ?too big? becomes Inefficient. Taxes go up, Inflation goes down.
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