Cost Structures and Supply

1. InputsAll inputs to production may be classified into the Factors of

Production:

• Land

• Labour

• Capital

• Enterprise

When examining allocative efficiency (best use of resources to satisfy consumer wants) ALL costs must be identified

• Explicit Costs: the costs of production paid to people outside of the business

• Implicit Costs: (imputed costs) the cost of resources owned by the business. These may include accounting costs (eg: depreciation) or opportunity costs (owner’s labour)

2. Economic and Accounting CostsAccounting Costs are the monetary costs of production

Accounting Costs Economic Costs

ScooterParts

$200$150

Total Accounting Costs $350

Sold for $550

Accounting Profit $200

Explicit Costs

ScooterParts

$200$150

Implicit Costs

Wages (20 hours @ $9/hour)Profit

$180$90

Total Economic Costs $620

Sold for $550

Economic Profit ($70)

Cost Structures and Supply

Economic Costs are ALL costs to the business, both accounting costs and opportunity costs. This opportunity cost will also include the opp cost of the owner, defined as the minimum profit required to keep the business open in the long term.

eg: Small Firm Refurbishing Scooters

3. Economic ProfitThis is defined as the difference between a firm’s revenue and its economic costs

• Normal Profit: revenue = costs, a firm is earning sufficient profit to stay open in the long term

Cost Structures and Supply

• Subnormal Profit: revenue < costs, a firm is earning less profit than expected and will close if this situation continues

• Supernormal Profit: revenue > costs, a firm is earning greater than expected profits

4a. Shape of the Cost Curves – Marginal Cost

Marginal Cost: the extra cost of producing an additional unit of output

MC

Output

Costs

Cost Structures and Supply

• where MC starts to rise, diminishing returns are setting in.

• MC initially falls, then rises (resembling a tick)

• the downward slope represents increasing returns to scale : inputs are used more efficiently as ouput is increased (see short-run economies)

Increasing returns

Diminishing Returns

The Law of Diminishing Returns:As additional inputs are added to a fixed amount of another input, the additional output will eventually fall.

eg: employ more workers while not increasing plant or machinery. Although output will increase, these increases will eventually get smaller with each additional worker.

In the short term, there are always some factors that are fixed in supplyIn the long term, all inputs are variable.

Inputs TotalOutput

Marginal Product(additions to output)

One worker 100

Two workers

Three workers

Four workers

Five workers

Six workers

250

100

150

400150

525125

625100

70075

increasing returns

constant returns

diminishing returns

diminishing returns

diminishing returns

eg: Large Firm Refurbishing Scooters

4b. Shape of the Cost Curves – Average Costs

Average Variable Cost: production costs per unit

MCAC

AVC

Output

Costs

Cost Structures and Supply

Average Cost is also U-shaped and derived from MC with non-production costs (fixed costs) also included

• the gap between AC and AVC represents average fixed costs so will get smaller as output is increased.

• AVC has a U-shape, and is derived from the MC curve

• while MC is below AVC, it will fall

• when MC is above AVC, it will rise

• so the MC curve cuts the AVC curve at its lowest point (this is also the most efficient point of

production)

Short-run economies and short-run diseconomies pg77

Make a VERY BRIEF note on each of these