1. Businesses and the Costs of Production 10 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Economic Costs The payment that must be made to obtain and retain the services of a resource Explicit Costs Monetary payments Implicit Costs Value of next best use Self-owned resources Includes normal profit LO1

3. Accounting Profit and Normal Profit Accounting profit = Revenue – Explicit Costs Economic profit = Accounting Profit – Implicit Costs Economic profit (to summarize) =Total Revenue – Economic Costs =Total Revenue – Explicit Costs – Implicit Costs LO1

4. Economic Profit LO1 Explicit costs Accounting costs (explicit costs only) Implicit costs (including a normal profit) Economic profit Accounting profit Economic (Opportunity) Costs Total Revenue

5. Short Run and Long Run Short Run Some variable inputs Fixed plant Long Run All inputs are variable Variable plant Firms enter and exit LO1

6. Short-Run Production Relationships Total Product (TP) Marginal Product (MP) Average Product (AP) LO2 Marginal Product Change in Total Product Change in Labor Input = Average Product Total Product Units of Labor =

7. The Law of Diminishing Returns LO2 TP MP AP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 123456789 0 10 20 30 Total Product, TP 123456789 20 10 Marginal Product, MP

8. Short-Run Production Costs Fixed Costs (TFC) Costs do not vary with output Variable Costs (TVC) Costs vary with output Total Costs (TC) Sum of TFC and TVC TC = TFC + TVC LO3

9. Short-Run Production Costs LO3 Costs 123456789 100 Q 100 200 300 400 500 600 700 800 900 1000 $1100 TFC TC TVC Total Cost Variable Cost Fixed Cost

10. Per-Unit, or Average, Costs Average Fixed CostsAFC = TFC/Q Average Variable CostsAVC = TVC/Q Average Total CostsATC = TC/Q Marginal CostsMC = ΔTC/ΔQ LO3

11. Per-Unit, or Average, Costs LO3 Costs 123456789 100 Q 50 100 150 $200 AFC ATC AVC AFC

12. Marginal Cost LO3 Costs 123456789 100 Q 50 100 150 $200 AFC MC ATC AVC AFC

13. MC and Marginal Product LO3 Average Product and Marginal Product Cost (Dollars) MP AP MC AVC Quantity of Output Quantity of Labor Production Curves Cost Curves

14. Long-Run Production Costs The firm can change all input amounts, including plant size. All costs are variable in the long run. Long run ATC Different short run ATCs LO4

15. The Long-Run Cost Curve LO4 Long-Run ATC Average Total Costs ATC-1 ATC-2 ATC-3 ATC-4 ATC-5 Output

16. Economies and Diseconomies of Scale Economies of scale Labor specialization Managerial specialization Efficient capital Other factors Constant returns to scale LO4

17. Economies and Diseconomies of Scale Diseconomies of scale Control and coordination problems Communication problems Worker alienation Shirking LO4

18. MES and Industry Structure Minimum Efficient Scale (MES): Lowest level of output where long- run average costs are minimized Can determine the structure of the industry LO4

19. MES and Industry Structure LO4 Output Average Total Costs Long-Run ATC Economies Of Scale Constant Returns To Scale Diseconomies Of Scale q1q1 q2q2

20. Don’t Cry Over Sunk Costs Sunk costs Costs have already been incurred and thus are irrecoverable Rule: Do not engage in any activity where MB<MC Rule: Ignore sunk costs They are irrecoverable