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