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Page 1: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned
Page 2: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

I. ECONOMIC COSTSI. ECONOMIC COSTS• Economic Costs are Opportunity Costs

• Explicit Costs – Resource payments like rent, labor, trucks,

vendors, fuel

• Implicit Costs– self-owned resources– lost value from investing in business

rather than alternative

Page 3: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

II. ECONOMIC PROFITII. ECONOMIC PROFIT

• Total Revenue MINUS Economic Costs

• AKA Pure profit

Page 4: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

EconomicProfit

Implicit costs(including a

normal profit)

ExplicitCosts

Accountingcosts (explicit

costs only)

AccountingProfit

Ec

on

om

ic (

op

po

rtu

nit

y) C

os

ts

TOTAL

REVENUE

Profits to anEconomist

Profits to anAccountant

Page 5: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

III. SHORT RUN & LONG RUNIII. SHORT RUN & LONG RUN

• Short Run – FIXED PLANT– Brief period of time to alter plant capacity– Output can be varied by adding larger/smaller

amounts of resources

• Long Run – VARIABLE PLANT– Enough time to change Q of ALL resources

employed including plant capacity– Firms can enter or exit industry

Page 6: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Inputs Total Product

Marginal Product

Average Product

0 0 Remember: Plot Between Input Points!

1 10 10 10

2 25 15 12.5

3 37 12 12.33

4 47 10 11.75

5 55 8 11

6 60 5 10

7 63 3 9

8 63 0 7.875

9 62 -1 6.88

Page 7: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Law of Diminishing ReturnsLaw of Diminishing Returns

SHORT-RUN PRODUCTIONRELATIONSHIPS

To

tal P

rod

uct

, TP

Quantity of Labor

Ave

rag

e P

rod

uct

, AP

, an

dM

arg

inal

Pro

du

ct, M

P

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

IncreasingMarginalReturns

Page 8: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Law of Diminishing Returns

SHORT-RUN PRODUCTIONRELATIONSHIPS

To

tal P

rod

uct

, TP

Quantity of Labor

Ave

rag

e P

rod

uct

, AP

, an

dM

arg

inal

Pro

du

ct, M

P

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

DiminishingMarginalReturns

Page 9: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Law of Diminishing Returns

SHORT-RUN PRODUCTIONRELATIONSHIPS

To

tal P

rod

uct

, TP

Quantity of Labor

Ave

rag

e P

rod

uct

, AP

, an

dM

arg

inal

Pro

du

ct, M

P

Quantity of Labor

Total Product

MarginalProduct

AverageProduct

NegativeMarginalReturns

Page 10: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

IV. Short Run Costs• Fixed Cost:

– Constant and must be paid no matter the output• Variable Cost

– Change with level of output• Total Cost

– FC + VC• Marginal Cost

– additional cost of producing one more unit of output

• Average Fixed Cost– TFC/Q

• Average Variable Cost – TVC/Q

• Average Total Cost – AFC + AVC– Or TC/Q

Page 11: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Output

Total

Fixed

Cost

Total

Variable

Cost

Total

Cost

Marginal

Cost

Average

Fixed

Cost

Average

Variable

Cost

Average

Total

Cost

0 $500 $0 $500PLOT BETWEEN OUTPUT LEVELS

100 500 700 1200 $7.00 $5.00 $7.00 $12.00

200 500 1300 1800 6.00 2.50 6.50 9.00

300 500 1800 2300 5.00 1.67 6.00 7.67

400 500 2400 2900 6.00 1.25 6.00 7.25

500 500 3100 3600 7.00 1.00 6.20 7.20

600 500 3820 4320 7.20 0.83 6.37 7.20

700 500 4700 5200 8.80 0.71 6.71 7.42

Page 12: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned
Page 13: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Total

Product

Fixed

Cost

Variable

Cost

Total

Cost

Marginal

Cost

Average

Fixed

Cost

Average

Variable

Cost

Average

Total

Cost

0 $100.00 $0 $100.00 ------- -------- ------- --------

1 100.00 10.00 110.00 $10.00 $100.00 $10.00 $110.00

2 100.00 16.00 116.00 6.00 50.00 8.00 58.00

3 100.00 21.00 121.00 5.00 33.33 7.00 40.33

4 100.00 26.00 126.00 5.00 25.00 6.50 31.50

5 100.00 30.00 130.00 4.00 20.00 6.00 26.00

6 100.00 36.00 136.00 6.00 16.67 6.00 22.67

7 100.00 45.50 145.50 9.50 14.29 6.50 20.79

8 100.00 56.00 156.00 10.50 12.50 7.00 19.50

9 100.00 72.00 172.00 16.00 11.11 8.00 19.11

10 100.00 90.00 190.00 18.00 10.00 9.00 19.00

11 100.00 109.00 209.00 19.00 9.09 9.90 19.00

12 100.00 130.00 230.00 21.00 8.33 10.83 19.16

13 100.00 160.00 260.00 30.00 7.69 12.31 20.00

Page 14: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

V. Perfect Competition• Price Taker (determined by industry)• Total Revenue = Price x Quantity• Marginal Revenue = Change TR / Change

Quantity• Average Revenue = TR/Q• Firms will produce where MR = MC

– Perfectly elastic demand for the firm– Maximize profits or minimize losses

• Economic Profit if MR=MC is greater than ATC• Economic Loss if MR=MC is below ATC• Firm will stay open as long as it can cover its

AVC• Firm will shut down if MR=MC is below AVC

Page 15: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Co

st a

nd

Rev

enu

eMC

MR

AVCATC

Economic Profit

MARGINAL REVENUE-MARGINAL COST APPROACH

Profit Maximization Position

Output Q

Page 16: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Co

st a

nd

Rev

enu

eMC

MRAVCATC

Economic Loss

MARGINAL REVENUE-MARGINAL COST APPROACH

Loss Minimization Position

OutputQ

Page 17: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Co

st a

nd

Rev

enu

eMC

MR

AVC

ATC

MARGINAL REVENUE-MARGINAL COST APPROACH

Short-Run Shut Down Point

Minimum AVCis the Shut-Down

Point

OutputQ

Page 18: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Co

st a

nd

Rev

enu

e, (

do

llar

s) MC

MR1

AVC

ATC

Quantity Supplied

MR2

MR3

MR4

MR5

P1

P2

P3

P4

P5

Q2 Q3 Q4 Q5

Marginal Cost & Short-Run Supply

Do notProduce –

Below AVC

Break-even(Normal Profit)Point

Page 19: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Co

st a

nd

Rev

enu

e, (

do

llar

s)MC

MR1

Quantity Supplied

MR2

MR3

MR4

MR5

P1

P2

P3

P4

P5

Q2 Q3 Q4 Q5

Yields theShort-Run

Supply Curve

Supply

NoProductionBelow AVC

Marginal Cost & Short-Run Supply

Page 20: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

AVC2

MC2

Higher Costs Move theSupply Curve to the LeftC

ost

an

d R

even

ue,

(d

oll

ars)

MC1

AVC1

Quantity Supplied

S1

S2

Marginal Cost & Short-Run Supply

Page 21: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

AVC2

MC2

Lower Costs Movethe Supply Curve

to the Right

Co

st a

nd

Rev

enu

e, (

do

llar

s)MC1

AVC1

Quantity Supplied

S1

S2

Marginal Cost & Short-Run Supply

Page 22: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Price

Quantity

S=MC

AVC

ATC

Q

D

Quantity

Q

D

S= MC’s

IndustryFirm

(price taker)

EconomicProfit

P

SHORT-RUN COMPETITIVE EQUILIBRIUM

The Competitive Firm “Takes” itsPrice from the Industry Equilibrium

Page 23: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

P

Q

S=MC

AVC

ATC

8

D

P

Q8000

D

S= MC’s

IndustryFirm(price taker)

EconomicProfit

$111$111

SHORT-RUN COMPETITIVE EQUILIBRIUM

The Competitive Firm “Takes” itsPrice from the Industry Equilibrium

How about thelong-run?

Page 24: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

PROFIT MAXIMIZATION IN THE LONG RUN

Assumptions...• Entry and Exit Only• Identical Costs• Constant-Cost IndustryGoal of the AnalysisPrice = Minimum ATCLong-Run Equilibrium - TheZero Economic Profit Model

Page 25: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Temporary profits and the reestablishmentof long-run equilibrium

S1

MCATC

P

Q100

P

Q100,000

IndustryFirm(price taker)

$60

50

40

$60

50

40

PROFIT MAXIMIZATION IN THE LONG-RUN

MR

D1

Page 26: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

An increase in demand increases profits.

MR

D1

MCATC

P

Q100

P

Q100,000

IndustryFirm(price taker)

$60

50

40

$60

50

40

PROFIT MAXIMIZATION IN THE LONG RUN

D2

EconomicProfits

S1

Page 27: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

New competitors increase supply and lowerprices decrease economic profits.

MR

D1

MCATC

P

Q100

P

Q100,000

IndustryFirm(price taker)

$60

50

40

$60

50

40

PROFIT MAXIMIZATION IN THE LONG RUN

D2

Zero EconomicProfits

S1

S2

Page 28: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

Decreases in demand, Losses, and the Reestablishment of Long-Run Equilibrium

S1

MCATC

P

Q100

P

Q100,000

IndustryFirm(price taker)

$60

50

40

$60

50

40

PROFIT MAXIMIZATION IN THE LONG RUN

D1

MR

Page 29: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

A decrease in demand creates losses.

MR

D1

MCATC

P

Q100

P

Q100,000

IndustryFirm(price taker)

$60

50

40

$60

50

40

PROFIT MAXIMIZATION IN THE LONG RUN

D2

EconomicLosses

S1

Page 30: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

MR

D1

MCATC

P

Q100

P

Q100,000

IndustryFirm(price taker)

$60

50

40

$60

50

40

PROFIT MAXIMIZATION IN THE LONG RUN

D2

Return to ZeroEconomic Profits

S1

S3

Competitors with losses decrease supply andprices return to zero economic profits.

Page 31: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY

Perfectly Elastic Long-Run Supply

Page 32: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

P

Q

=$50 S

D1

Z1

Q1

D2

Z2

Q2Q3

D3

Z3

100,000 110,00090,000

LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY

P1

P2

P3

Page 33: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

P

Q

=$50 S

D1

Z1

Q1

D2

Z2

Q2Q3

D3

Z3

100,000 110,00090,000

LONG-RUN SUPPLY IN ACONSTANT COST INDUSTRY

P1

P2

P3

Page 34: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

P

Q

$555045

S

D1

Y1

Q1

D2

Y2

Q2Q3

D3

Y3

100,000 110,00090,000

LONG-RUN SUPPLY IN ANINCREASING COST INDUSTRY

P1

P2

P3

Page 35: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

P MR

Q

MCATC

Quantity

Pri

ce

Price = MC = Minimum ATC(normal profit)

LONG-RUN EQUILIBRIUM FOR A COMPETITIVE FIRM

Page 36: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

PURE COMPETITION AND EFFICIENCY

Productive EfficiencyPrice = Minimum ATC

Allocative EfficiencyPrice = MC

UnderallocationPrice > MC

OverallocationPrice < MC

Page 37: I. ECONOMIC COSTS Economic Costs are Opportunity Costs Explicit Costs –Resource payments like rent, labor, trucks, vendors, fuel Implicit Costs –self-owned

PURE COMPETITION AND EFFICIENCY

Productive EfficiencyPrice = Minimum ATC

Allocative EfficiencyPrice = MC

UnderallocationPrice > MC

OverallocationPrice < MC

Resources are

efficiently allocated

under competition.


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