# Cost schedules include the market value of all resources used in the production process.

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1 By the end of this learning plan, you will be able to: Relate factor markets to production Assess the role price plays in a market economy Use marginal (Cost-Benefit) analysis in decision-making Cost schedules include the market value of all resources used in the production process. So Total Cost = Explicit Costs + Implicit Costs 2 Explicit Costs: Payments made to others as the cost of running the business E.g. wages, rent Implicit Costs: The value of the resources used in production for which no monetary payment is made E.g. wages forgone, interest forgone 3 1

2 Accounting Profit = TR Explicit Costs Economic Profit = TR (Explicit Costs + Implicit Costs) Accounting profit underestimates the costs and thus overestimates the profits 4 Yes! It is called normal profit. Normal profit is when TR = Explicit Costs + Implicit Costs E.g. Wages forgone 5 Production is the use of resources to make outputs of goods and services available for human wants. Flash from the past What are resources? 6 2

3 The relationship between the physical output and the quantity of the resources used in the production process. A cookie recipe is a production function. 7 A period where at least one input is fixed and the others can be varied. 8 Fixed Inputs any resource for which the quantity can t be varied during the period in question E.g. land, size of factory Variable Inputs quantities that can change in the short run E.g. labor, materials 9 3

4 A period where all inputs are variable. NO FIXED INPUTS! How long is the long run? Well, it depends on the business. Krispie Kreme can change the number of franchises in a matter of months, but to construct a new factory for GM could take a while 10 Total product 5800 Total product curve TP Marginal product Marginal product curve Increasing marginal returns Diminishing marginal returns MP Labor input Labor input 11 The law says that marginal product decreases as additional units of the variable resource is added. 12 4

5 When we look at total product and marginal product, we held Technology Quality of human resources Amount of capital equipment constant. 13 But what if we allowed those to change also? It will shift the product curves! New Technology Less Education More Training Less Investment Less R&D 14 Total fixed costs: costs that don t vary with the output (a.k.a. overhead costs) E.g. costs of machinery, rent, taxes They remain constant in the short run Total variable costs: costs that change at the rate the output changes E.g. labor, materials, electricity 15 5

6 Total costs are the sum of the value of all resources used over a given period to manufacture a product TC = TFC + TVC 16 Most managers though, care about the per-unit or average costs. Average fixed costs: TFC/Q Average variable costs: TVC/Q ATC: TC/Q or TFC/Q + TVC/Q AFC + AVC 17 Managers are also concerned with the margin, so Marginal Cost = TC/ Q 18 6

7 Total cost Total Cost Costs Average total cost Total variable cost Average variable cost 50 Total fixed cost Marginal cost Output per day Output per day 19 Before, we assumed Technology Resource prices Taxes were constant. But what if they changed? 20 All costs are now variable, they can change. Long Run Average Total Cost Curve: shows the minimum cost per unit of producing each output level when any proper size factory could be built. 21 7

8 The Relationship Between Three Factory Sizes and the Long-Run Average Cost Curves Cost per unit (dollars) A B SRATC s SRATC m SRATC l D LRAC C Quantity of output (units per hour) 22 Long-run Average Cost Curves Cost per unit (dollars) Short-run average total cost curves Long-run average cost curve Quantity of output (units per hour) 23 Long-run Average Cost Curve Cost per unit (dollars) LRAC Economies of scale Constant returns to scale Diseconomies of scale 0 Q 2 Q 1 Quantity of output 24 8

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