1. Chapter 4 – Costs of Production
Part II
Chapter 4 – Costs of Production

2. Activity
Money.. Incentive => Implicit Cost

3. Explicit vs Implicit Cost
Explicit costs are expenses for which one must pay with cash or equivalent. Because a cash transaction is involved, they are relatively easily accounted for in analysis. These costs are never hidden, one has to pay separately. (Follow the money!) Example- Electricity Bill, wages to workers etc.
Implicit costs do not involve a cash transaction, and so we use the opportunity cost concept to measure them. Implicit costs are related to forgone benefits of any single transaction. These are intangible costs that are not easily accounted for. (Opportunity Cost)
Example, the time and effort that an owner puts into the maintenance of the company rather than working on expansion.

4. 1. The sole proprietor of the "Books and More" bookstore receives all accounting profits earned by her firm and a $28,000-a-year salary she pays herself. She has a standing salary offer of $35,000 a year if she agrees to work for a large corporation. If she had invested her capital outside her own company, she estimates that would have returned $22,000 a year. Last year, her accounting profit was $50,000. What was her economic profit?

5. What are her Implicit Costs?
She says that she currently makes $28,000 / yr
She COULD be making $35,000 if she works for a large corporation
We can deduce that she is “losing” $7,000 by not taking the other job that pays more.. Therefore her opportunity cost for her time is $7,000
If she had invested her capital ($$) into something, she would have made $22,000
Total Implicit cost = $7, ,000 = $29,000

6. EP = AP + EC – IC – EC = AP – IC EP = AP - IC
EP = TR – (Total Costs)
EP = TR – (IC + EC)
EP = TR – IC – EC
AP = TR – EC
AP + EC = TR
TR= AP + EC
Sub TR into EP’s TR
EP = AP + EC – IC – EC = AP – IC
EP = AP - IC

7. Economic Profit = Accounting Profit – Implicit Cost
EP = 50,000 – 29,000 = $21,000

8. Learning Objectives
Know how to calculate total, average and marginal product values

9. Economic Costs Economic costs include:
explicit costs, which are payments to resource supplies outside a business
implicit costs, which are what owners give up by being involved in a business
Economic profit is found by subtracting economic costs (both explicit and implicit) from total revenue.

10. Accounting versus Economic Profit
Accounting profit is total revenue minus explicit costs.
Because accountants consider only explicit costs, accounting profit always exceeds economic profit by the amount of the business’s implicit costs.

11. Production in the Short Run (a)
some inputs (such as capital) are fixed (cannot be adjusted in SH)
other inputs (such as labour) are variable (can be adjusted)
Examples: Labour, Materials
DrLaiManufacturer produces 10 lambos a day. Mr. Lai is thinking of increasing current production to 20! In the short run, I cannot acquire more machines right away, so the machines I have represent a fixed input. I can, however, hire more workers and have them work longer which represent my variable input

12. Inputs are combined to make total product.
The overall quantity of output produced with a given workforce
Includes all variable inputs
Other product measures include:
average product, which is total product divided by the number of workers
marginal product, which is the extra total product associated with an additional worker

13. Average Product The quantity of output produced per worker
Average Product = Total Product (q) # of workers (L)

14. Marginal Product The extra output produced by an additional worker
Marginal Product = Change in total product Change in workforce

15. Total, Marginal, and Average Products1 2 3 4 5 6
Number of Workers Employed per Day
T-Shirts Produced per Day 50
100
150
200
250
300
Labour
(L)
(workers
per day)
Total
Product
(q)
(T-shirts
Marginal
(Δq/ΔL)
Average
(q/L) 1 2 3 4 5 6 TP 80
200
250
270
280 -- 80
100
83.3
67.5 56 45 80
120 50 20 10
-10 1 2 3 4 5 6
Number of Workers Employed per Day
T-Shirts Produced per Day 40 60 80
100
120
-20 20
Diminishing
returns set in AP MP

16. When employing 3 workers, the workforce average product is 83.3
(250 shirts /3 workers)
If a Fourth worker is added?, what is the marginal product?
Change in Total Product / Change in Workforce
( ) / 3 = 20 shirts
Therefore by adding an extra worker (from 3 to 4), we are able to output 20 extra shirts (from 250 to 270)
Labour
(L)
(workers
per day)
Total
Product
(q)
(T-shirts
Marginal
(Δq/ΔL)
Average
(q/L) 1 2 3 4 5 6 80
200
250
270
280 -- 80
100
83.3
67.5 56 45 80
120 50 20 10
-10

17. What is the Average Product when employed 5 workers?
Total Product / Labour
280 / 5 = 56 Product/ Labour
What is the Marginal Product if we go from 5 workers to 6?
Change in Total Product / Change in Workforce
( )/(6-5) = -10 shirts
Whoa! What just happened?

18. The Law of Diminishing Marginal Returns
Short-run production is determined by the law of diminishing marginal returns. According to this law:
the addition of more variable input causes marginal product to fall after some point
average product also falls after some point
Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

19. Rest of Class
Do worksheet Questions