The Costs of Production Chapter 8 (155-156)

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The Costs of ProductionChapter 8 (155-156)

• Mr. Henry
• AP Economics

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Behavior of Producers

• One of the big questions facing producers is what
  economic resources to obtain and what to produce
  with these resources?

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Economic Cost

• When society uses a combination of resources to
  produce a particular product, it gives up all
  other alternative uses of that resource. This is
  known as the economic cost, or opportunity cost.

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If you were the owner of an industry, what would
you use your steel for?
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Explicit vs. Implicit Costs

• Explicit Costs are the monetary payments
  (expenditures) it makes to those who supply labor
  services, materials, fuel, transportation.
  Payments for the use of resources owned by
  others.
• Implicit costs are the opportunity costs of using
  its self-owned, self-employed resources.
  Implicit costs are the money payments that
  self-employed resources could have earned in
  their best alternative use.

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ExampleMr. Henry opens a daycare. Yes, it may
seem like I make more money being my own boss
owner, but I have explicit costs my implicit
costs are my foregone costs like rent, wages, etc.
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Normal Profit

• The payment made by a firm to obtain and retain
  entrepreneurial ability the minimum income
  entrepreneurial ability must receive to induce it
  to perform entrepreneurial functions for a firm.
• Normal profits are considered an implicit cost
  because they are the minimum payments required to
  keep the owners entrepreneurial abilities self
  employed. So in my example, maybe my ability is
  worth 10,000.

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Economic or pure profits are total revenue less
all costs (explicit and implicit including a
normal profit).Economic Profit TR-ECEX. On
next page economic profits are 24,000 (after
63,000EP 33,000IP are subtracted from
120,000TR).
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Practice
Gomez runs a small pottery firm. He hires one
helper at 12,000 per year, pays annual rent of
5,000 for his shop, and spends 20,000 per year
on materials. He has 40,000 of his own funds
invested in equipment (pottery wheels, kilns, and
so forth) that could earn him 4,000 per year if
alternatively invested. He has been offered
15,000 per year to work as a potter for a
competitor. He estimates his entrepreneurial
talents are worth 3,000 per year. Total annual
revenue from pottery sales is 72,000. Calculate
accounting profits and economic profits for
Gomezs pottery.
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Practice
Explicit costs 37,000 ( 12,000 for the
helper 5,000 of rent 20,000 of materials).
Implicit costs 22,000 ( 4,000 of forgone
interest 15,000 of forgone salary 3,000 of
entreprenuership). Accounting profit 35,000
( 72,000 of revenue - 37,000 of explicit
costs) Economic profit 13,000 ( 72,000 -
37,000 of explicit costs - 22,000 of implicit
costs).
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Example of production in the short run

• Imagine the room you are in is a cookie factory
• The fixed input is the production facility and it
  includes refrigerators, bowls, mixers, ovens,
  tables and other stuff. The variable input will
  be labor. In a short run, the production period
  is so short that only the variable inputs
  (usually labor, materials, and other resources)
  to the plant can be changed

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What are examples of variables in the short run
at your place of employment?
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Long Run

• The long run is the period long enough for it to
  adjust the quantities of all the resources that
  it employs, including plant capacity.
• The long run is a variable-plant period meaning
  that new buildings or new equipment can be added.

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What are examples of the long run at your place
of employment?