Explicit vs' Implicit Costs

1
Explicit vs. Implicit Costs

• Explicit Costs Actual payments made.
• Implicit Costs No actual payment made
• Opportunity cost of resource firm owns
• e.g., owner could earn 15K as teacher,
  implicitly foregone to run firm.
• Economic (Opportunity) costs include explicit
  and implicit costs

2
Accounting vs. Economic Profit

• Accounting Profit Revenue - Explicit Costs
• Economic Profit Revenue - Opportunity
  (Explicit Implicit) Costs
• Econ Profit accounts for owners next best
  alternative
• e.g.., implicit costs15K, explicit costs100K,
  revenues300K
• Accounting Profit ??
• Economic Profit ??

3

• Zero (normal) economic profit
• Just enough to keep owner in business and
  resources employed there
• Just equal to its next best alternative.
• e.g.., owner earned 115K revenues, econ profit
  0
• Sunk costs
• Irrelevant to decision-making
• Incurred by past decisions, cant be undone
• Examples?

4
Production and Costs

• Producing goods requires resources, time, and
  incurring costs
• Well focus on 3 costs Total Cost (TC), Average
  Total Cost (ATC), Marginal Cost (MC)
• TC Cost of using inputs to produce given output
• ATC (Total Cost) / (Output)
• MC D in TC from producing one more unit of
  output (D TC) / (D Output)

5

• Numerical examples
• Total Cost of 1st unit 150
• Total Cost of 2nd unit 180
• Then for 2nd unit produced
• ATC 180 / 2 90
• (NOTE Total Cost ATC x Output 2 x 90 180)
• Marginal Cost TC of 2nd unit (180) - TC of
  1st unit (150) 30

6
Marginal Physical Product (MPP), Diminishing
Marginal Returns, and MC

• MPP Extra output from hiring another unit of
  input (e.g., labor hour)
• MPP (D Output) / (D Input)
• Law of Diminishing Marginal Returns
• As more input added (to fixed inputs), its
  additional productivity declines
• Adding another unit increases output by less than
  previous one.
• MPP at some point declines

7
Diminishing Marginal Returns Underlies Concept of
Marginal Cost (MC)

• MC D in cost associated with D in Output
  (D TC) / (D Q)
• Changing output means hiring extra inputs
• If MPP increases, MC of producing declines
• But as diminishing marginal returns sets in, MPP
  declines

8

• Diminish. marginal returns means MC rises
• As inputs productivity (MPP) declines, why must
  (MC) increase?
• What happens to firms MC if diminishing marginal
  returns never set in?

9
MPP MC move in Opposite Directions (using
examples in text)
Marginal Cost ()
MPP
MC
1.25
20
1.17
19
1.11
18
1.05
17
MPP
1.00
18
37
111
76
57
127
94
1
3
5
7
2
4
6
Number of Workers
Output
10
Shape of ATC Curve Average-Marginal Rule

• Marginal gt average means average rises
• Marginal lt average means average falls
• Marginal pulls Average in same direction
• Example Average of 3 quizzes 80, 4th quiz
  90
• Does Marginal Quiz (4th) pull average up/down?

11
Relation Between Average Total Cost and Marginal
Cost

• ATC decreasing when MC lt ATC
• ATC increasing when MC gt ATC
• At minimum ATC, MC ATC
• Minimized per unit cost

Cost
MC
ATC
Output
QMin
12
Shifts in Cost Curves

• Taxes per unit produced
• Input Prices
• Improved Technology