# Costs of Production. Total Revenue - the amount a firm receives for the sale of its output.

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1 Costs of Production Total Revenue - the amount a firm receives for the sale of its output. TR = P x Q Total Cost - the value of the inputs a firm uses in production. TC = FC + VC Profit is the firm s total revenue minus its total cost. P = TR -TC

2 Accountants look at only EXPLICIT COSTS Explicit costs (out of pocket costs) are payments paid by firms for using the resources of others. Example: rent, wages, materials Accounting profit = total revenue explicit costs (and depreciation) Economists examine both EXPLICIT COSTS and IMPLICIT COSTS Implicit costs are the opportunity costs that firms pay for using their own resources Example: forgone wage, rent, time Economic profit = total revenue explicit costs and implicit costs

3 You own and operate a bike store. Each year, you receive revenue of \$200,000 from your bike sales, and it costs you \$100,000 to obtain the bikes. In addition, you pay \$20,000 for electricity, taxes, and other expenses per year. Instead of running the bike store, you could be an accountant and receive a yearly salary of \$40,000. A large clothing retail chain wants to expand and offers to rent the store from you for \$50,000 per year. Accounting profit = total revenue explicit costs (and depreciation) ACCOUNTING PROFIT \$200,000 (total revenue) \$100,000 (cost of bikes) \$20,000 (electricity, taxes, and other expenses) = \$80,000

4 You own and operate a bike store. Each year, you receive revenue of \$200,000 from your bike sales, and it costs you \$100,000 to obtain the bikes. In addition, you pay \$20,000 for electricity, taxes, and other expenses per year. Instead of running the bike store, you could be an accountant and receive a yearly salary of \$40,000. A large clothing retail chain wants to expand and offers to rent the store from you for \$50,000 per year. Economic profit = total revenue explicit costs and implicit costs OPPORTUNITY COST? not renting the store for \$50,000 and \$40,000 salary ECONOMIC PROFIT: \$200,000 (total revenue) \$100,000 (cost of bikes) \$20,000 (electricity, taxes, and other expenses) \$40,000 (opportunity cost of your time) \$50,000 (opportunity cost of not renting the store) = - \$10,000 So although you make an accounting profit each year, you would be better off renting the store to the large chain and being an accountant since your opportunity cost of continuing to run your own store is too high.

5 Positive economic profit : TR > implicit + explicit à DO IT! Negative economic profit: TR < implicit + explicit à SKIP IT! Should a firm be worried if it is earning zero economic profit? Accounting Profits > Economic Profits No, a firm earning zero (normal) economic profit has still earned enough revenue to cover explicit and implicit costs. Since its not negative, it means the firm could not do any better using its resources in an alternative activity.

6 You own and operate a bike store. Each year, you receive revenue of \$200,000 from your bike sales, and it costs you \$100,000 to obtain the bikes. In addition, you pay \$20,000 for electricity, taxes, and other expenses per year. Instead of running the bike store, you could be an accountant and receive a yearly salary of \$30,000. A large clothing retail chain wants to expand and offers to rent the store from you for \$50,000 per year. Economic profit = total revenue explicit costs and implicit costs OPPORTUNITY COST? ECONOMIC PROFIT: \$200,000 (total revenue) \$100,000 (cost of bikes) \$20,000 (electricity, taxes, and other expenses) \$30,000 (opportunity cost of your time) \$50,000 (opportunity cost of not renting the store) You should own and operate the bike store since you have earned normal profits. Your accounting profit is \$80,000 and that s what you would now pay yourself for owning the bike store. In this scenario, you would not be better off being an accountant and renting out your store. = \$0 not renting the store for \$50,000 and \$30,000 salary

7 Economic Profits Positive economic profit = TR > implicit + explicit à DO IT! A positive economic profit indicates the current use is the best use of resources. From now on, we only deal A negative economic profit indicates is a better alternative use of resources. withthere ECONOMIC Economic profit is never higher than accounting profit since it accounts for COSTS/PROFITS opportunity costs. Thus it is possible for a firm to earn positive accounting profits and zero economic profit. (IMPLICITS COST ARE Should a firm be worried if it is earning zero economic profits? INCLUDED). Negative economic profit = TR < implicit + explicit à SKIP IT No, a firm earning zero/normal economic profit has still earned enough revenue to cover his/her implicit and explicit costs. Since its not negative, it means the firm could not do any better using its resources in an alternative activity.

8 Costs (dollars) TC of 11 units? If each unit sells for \$7, what is total revenue? Economic profit? MC Should the producer exit this industry? ATC AVC No, the producer is earning zero (normal) economic profits, which means he/she is earning positive accounting profits. AFC Quantity