Costs of Production

COSTS ( in Economics ) that deal with forgoing the opportunity to produce alternative goods and services. The OPPORTUNITY COST of producing a good is its value or worth in its best alternative use. ECONOMIC COSTS

Explicit costs are those payments a firm must make, or incomes it must provide to resource suppliers to attract these resources away from alternative production opportunities. EXPLICIT COSTS

Examples: payments to hired labor payments to vendors payments for rent or mortgage payments for trucks, etc.

IMPLICIT COSTS Costs of self-owned, self- employed resources Money payments the self- employed resources could have earned in their next best alterative employments.

IMPLICIT COSTS Examples: value lost by investing in business instead of alternative investment value lost in working for someone else value lost by not using entrepreneurial skill in another way

Amount remaining from revenue less those costs to attract and retain resources in a given line of production. Minimum return needed by entrepreneur to stay in business If not realized, entrepreneur will reallocate resources to more attractive pursuits. NORMAL PROFITS

Total Revenue minus all Costs ECONOMIC PROFITS Costs will include both explicit and implicit costs Implicit costs will include the normal profit

Economic profit is not a cost! … it is a return in excess of the normal profit required to retain the entrepreneur Economic profits = Total revenue —opportunity costs of all inputs ECONOMIC PROFITS

ECONOMIC PROFITS Implicit Costs including Normal Profit Explicit Costs ACCOUNTING PROFITS ACCOUNTING COSTS explicit costs only TOTAL REVENUETOTAL REVENUE ECONOMICECONOMIC COSTSCOSTS

Gomez runs a small firm which makes pottery. He hires one helper at $12,000 per year, pays annual rent of $5,000 and materials cost $20,000 per year. Gomez has $40,000 of his own funds invested in equipment which could have earned $4,000. Gomez has been offered $15,000 to work as a potter for a competitor. He estimates his entrepreneurial skills are worth $3,000 per year. Explicit Costs? Implicit Costs?

Explicit costs: $12,000 + $5,000 + $20,000 = $37,000 Implicit Costs: $4,000 + $15,000+ $3,000 = $22,000

If Total Revenue is $72,000 If Total Revenue is $72,000 Economic Profits $72,000— $37,000—$22,000 = $13,000 Accounting Profits $72,000— $37,000 = $35,000 Explicit costs: $37,000 Explicit costs:$37,000 Implicit costs:$22,000

Short Run FIXED PLANT Period of time too brief for firm to alter its plant capacity Output can be varied by adding larger or smaller amounts of labor, materials, and other resources. Existing plant capacity can be used more or less intensively

Long Run VARIABLE PLANT Period of time long enough to change the quantities of ALL resources employed, including plant capacity. Enough time for existing firms to dissolve and exit the industry OR for new firms to form and enter the industry.