Transcript Markets
Theory of the Firm Part I Costs - Part 1 (Section 4.1 of textbook) M. Padula AIS 2011-12 J. Holcomb AIS 2010 Upcoming Topics Introduction to Costs Accounting vs. Implicit Costs Short-term vs. Long-term Fixed, Variable, and total Costs Marginal Costs Cost of Production Total product, marginal product, average product Marginal and Average cost curves The Law of Diminishing Marginal Return Short Run Cost Curves Shifts in SR Cost Curves Let’s start with a little discussion… http://www.bized.co.uk/educators/1619/economics/firms/activity/costs.htm Definitions – What is cost? All costs can be viewed as Opportunity Costs Think about alternative uses & sacrifice Opportunity Cost = Value of the next best alternative that must be sacrificed in order to obtain something Definitions – What is cost? All costs are either Accounting Costs… Firm purchases from other entity – think of labor, rent Aka “Explicit cost” or “price” Recorded in the accountant’s books Opportunity cost = what else could have been purchased? Or…Implicit Costs… No explicit payment made – but a cost Opportunity cost = what else could have been done with that resource? What other income could have been earned with that resource? Economic Costs Accounting Costs + Implicit Costs Example: Career Change You are contemplating a career change: Current job pays $80,000 Considering starting your own business Use home office in room that can rent for $4,000/year Borrow $30,000 to get started, interest will be $2000/year Use the $30,000 to buy supplies and materials to get started Hire an assistant at $25,000 Example: Career Change Source of Cost Accounting Cost? Interest on loan ($2,000) Supplies and material ($30,000) Assistant salary ($25,000) What else? What else? TOTALS What is the total Economic Cost? Implicit Cost? The Short Run and the Long Run First, a reminder about the factors of production (inputs): • Land – all natural resources of the earth – not just ‘terra firma’! Price paid to acquire land = Rent • Labor – all physical and mental human effort involved in production Price paid to labor = Wages • Capital – buildings, machinery and equipment used in production Price paid for capital = Interest • Entrepreneurship/Management – Innovation, risk-taking, run a business Profit is the payment to owners of entrepreneurship The Short Run and the Long Run In the Short Run: All but one of the four factors of production can be changed In the Long Run: All factors of production can be changed Theoretical; firm approaches the long run but it does not arrive Example: Firm anticipates higher demand, wants to increase production Can hire more labor, increase materials/equipment Can not change the size of buildings, factories, machinery In the long run, even the buildings, factories, and machinery can be changes Note: Short-run vs. Long-run is not a specified length of time. Costs: FC, VC, TC Fixed Costs Costs that do not vary with output (even when output is zero) Examples: Rent, Property taxes, Insurance, Interest on Loans Variable Costs Costs that do vary with output Examples: Labor (Wages/Payroll tax/Benefits), Fuel, Shipping Total Costs TC = FC + VC In the long run, ALL inputs are variable—all costs are variable Marginal Costs Cost of producing one more Costs: AC, MC Average Costs Cost per unit of output –what is the total cost divided by the total output? Average Fixed Cost = Total Fixed Cost/Output Average Variable Cost = Total Variable Cost/Output Average Total Cost (ATC) = (AFC) + (AVC) Marginal Costs Cost of producing one more unit of output What is the increase in (Variable) cost for one more unit of output MC = ∆TC/∆Q = ∆TVC/∆Q Your Turn Test Your Understanding 4.1 Page 94