1. Costs Curves Diminishing Returns
Accounting Costs
Economic Costs
Supply

2. ACCOUNTING COSTS Accounting costs are monetary (usually explicit).
Accounting profit = Revenue – Accounting costs.

3. ECONOMIC COSTS Economic costs = accounting costs + opportunity costs.
Economic profit = revenue – economic costs.
Economic profit = revenue – (accounting costs + opportunity costs).

4. ECONOMIC COSTS Economic costs = accounting costs + opportunity costs.
In economic analysis we use economic costs.
To make a wise decision we need to consider all costs and not only monetary costs.
Opportunity costs should be considered as they have an important bearing on our decision making. These include opportunity cost for resources owned by the firm itself.

5. OPPORTUNITY COSTS Accounting profit Economic profit $$40,000
Bill owns a farm worth $1m. His yearly revenue is $100,000 and his expenses are $60,000. The current interest rate is 5% for savings. What is Bill’s accounting profit and what is his economic profit?
Accounting profit
$$40,000
Economic profit
-($10,000)

6. OPPORTUNITY COSTS Economic profit Accounting profit -($5000) $20000
Chen runs her own business. She receives no wage or salary. She could work full-time for $25,000pa. Her business revenue for last year was $30,000 and her expenses $10,000. What is her accounting profit and her economic profit?
Economic profit
-($5000)
Accounting profit
$20000

7. OPPORTUNITY COSTS
Tao must travel from Wellington to Auckland for business. Tao is paid $20 per hour and he must travel in work time. Prices and times are:
Mode
Price $
Hours
Plane
$150 1
Car
$100 6
Bus
$70 10
Plane is cheapest. If we consider opportunity costs, total cost for plane travel is $170 – much cheaper than the other options.
Which is
cheapest?

8. Economic costs in more detail
Rent- Economic return to land (return to any factor that is in fixed supply)
Wages- Economic return to labour. It includes all ways people a compensated for providing their time, efforts and skills. (except for enterprise)
Interest- Economic return on capital.
Profit- Economic return to enterprise for taking risk. It is the reward to those who run the risk of failure when they bring together all the other factors of production

9. Do this Now
Last year Mona had a job as a manager for a fishing company, which paid her $65,000 a year,
She had $80,000 in savings, which gave her a rate of return of 10%.
She thought she could do better by going fishing herself, so gave up her job and invested $80,000 of her own money in buying a fishing boat and quota.
By the end of the first year she had sold $140,000 worth of fish and her costs of running the business had been $70,000. She expected the costs to be quite high in the first year, because she was getting the business established, but though these would fall in future years.
1. Calculate her accounting profit
2. Calculate her economic profit
3. Which are always greater? Economic or accounting profits? Explain

10. Answers! 1. Calculate her accounting profit Revenue - Accounting costs
140,000 – 70,000 = 70,000
2. Calculate her economic profit
Revenue – Economic Costs (accounting costs + opportunity costs)
140,000 – 70,000 – 65,000- (80,000 x0.10) = -3000
3. Which are always greater? Economic or accounting profits? Explain
Accounting profits are equal to Revenue minus accounting costs. Economic profits are equal to revenue minus accounting costs and opportunity costs. Thus Accounting profits will always be greater than Economic profits due to economic profits taking into account an extra cost, opportunity costs.

11. Fixed costs are costs that do not vary with outputQ FC VC TC
100 1 2 3

12. Fixed costs are costs that do not vary with outputQ FC VC TC
100 1 30 2 50 3 80
Variable costs are costs that increase as output increases

13. Fixed costs are costs that do not vary with outputQ FC VC TC
100 1 30
130 2 50
150 3 80
180
Variable costs are costs that increase as output increases
Total costs = Fixed + Variable costs

14. FC, VC & TC Fixed costs are costs that do not vary with output TC
Total costs = Fixed + Variable costs
Costs($) VC
Variable costs are costs that increase as output increases
Quantity

15. Average and Marginal Cost
Output (Q)
Total Cost
Average Cost
Marginal Cost
100 - 1
200 2
320
160
120 3
420
140 4
640
220 5
1100
460
AC = TC/Q

16. Average and Marginal Cost
Output (Q)
Total Cost
Average Cost
Marginal Cost
100 - 1
200 2
320
160
120 3
420
140 4
640
220 5
1100
460
AC = TC/Q
MC = TC2 - TC1

17. Starter Activity
Number of people in the group (Workers)
Total Product
Marginal Product 1 2 3 4
We will assume all groups are equally skilled, so the marginal product is the difference between group one’s total and group two’s total product.
Graph the number of workers on the horizontal axis against the number of blocks sorted on the vertical axis.
What do you notice?

18. Short-run costs
In economics we distinguish between various time periods - ie short and long run.
The short run, which our particular concern, is a period when at least one input to the production process is fixed.
This means that in the short run all production will be subject to the law of diminishing return.
fig

19. Diminishing Returns
The law of diminishing returns states that where additional units of a variable input are added to a fixed amount of another input, the additional output, or marginal product, will eventually fall.

20. Diminishing Returns Fixed Input Variable input
The additional output(MP) eventually falls
Fixed Input
Variable input

21. The Shape of the MC curve
Costs($)
MC decreases initially because of increasing returns
Note: always plot the MC curve at the mid-point!
MC increases because of diminishing returns
Quantity

22. The Shape of Average Cost Curves
Costs($)
FC are constant so AFC will continually decline as FC are spread over increasing output
AFC FC
Quantity

23. The Shape of Average Cost Curves
Costs($) AC
AC decreases because of short run economies:
Technical
Marketing
Managerial
Financial
AFC
Quantity

24. The Shape of Average Cost Curves
Costs($) AC
AC increases as short run diseconomies set in.
AFC
Quantity

25. The Shape of Average Cost Curves
Costs($) AC
The difference between AC and AVC is equal to AFC
AVC
AFC
Quantity

26. Marginal Cost & Average CostMC
Costs($) AC
If MC<AC then AC will be decreasing
Quantity

27. Marginal Cost & Average CostMC
Costs($) AC
If MC>AC then AC will be increasing
Quantity

28. Marginal Cost & Average CostMC
Costs($) AC
MC cuts AC at its minimum point - this is the technical optimum
Quantity

29. Marginal Cost & Average Variable CostMC
Costs($) AC
MC also cuts AVC at its minimum point
AVC
Quantity

30. Break Even & Shut Down MC AC
Costs($) AC
A firm must cover AC if it is to break even
AVC
This is the break even point
Break even point is where AR=AC.
Where the price is enough to cover all costs and the firms make normal profits.
Quantity

31. Break Even & Shut Down MC AC
Costs($) AC
In the SR a firm can survive if P > AVC
AVC
This is the shut down point
Quantity

32. The Supply Curve MC =S AC AVC
A firm’s Supply curve is derived from the MC curve above the shut-down point
The Supply Curve MC =S
Why do you think the supply curve is upwards sloping?
Costs($) AC
AVC
Because of diminishing returns!
Producing higher levels of output results in progressively less efficient resource combinations. Because of this the firm will only supply a larger quantity at higher prices.
Quantity