22nd, February 2012
Today and next two lectures:
Cost
I. Perspective
Firms goal: maximize total profit
Can be major corporations, shareholders with stocks
Total profit: ( TT [pi])
Total profit= total revenue total cost
II. Basic Principles of Cost
1. Cost relates to a decision
ex: decision to produce one more output- should you increase or not?
What is the cost of producing an additional product?
Ex: cost of changing your major
2. Cost is opportunity cost
ex: decide to keep business or sell the business for 100k by deciding to keep the business
operating, sacrificing the 100k (opportunity cost)
3. Cost is measured in dollars
4. Cost is a flow (for firms)
stock variable: quantity that can be measured at a moment in time
ex: wealth; how many gallons of water in the tub
flow variable: process that takes place over a period in time
ex: net worth ; saving (rate at which your adding to your net); revenue; profit; COST
ex: the rate at which water is flowing into the tub (the additional flow of water into the
tub)
flow variable ALWAYS has per time attached to it (per minute/day)
time duration is always implied
when firms make business decisions, cost are always a flow variable because profits are
flow variables
5. Sunk costs are irrelevant and not considered part of cost
a cost that has already been paid or must be paid in the future regardless of your decision
Ex: non-refundable ticket: the cost of the ticket is a sunk cost bc you pre-paid the
ticket for
ex: a business firm that signs a contract for 1 year regardless of any decision it makesthis is a sunk cost for the company
the rent: sunk cost because it has already been paid
III. Types of Cost
A. Explicit vs. Implicit
explicit: opportunity cost where money changes hands
money has to be paid out
implicit: cost where money is not paid out
Example:
Explicit
labor costs
raw materials
rent payment
interest payments
Implicit
Depreciation : the using up of capital stock (ex: physical
capital- office space, tools) Every year you
use it, the items are getting used up
foregone interest: interest cost instead of borrowing
money you invested your own money
foregone rent: rent- renting it out to someone else)
foregone salary (owner)
B. Accounting vs. Economic
accounting cost vs economic cost (aka cost = opportunity cost=explicit= all implicit)
accounting: explicit cost and depreciation
implicit cost (depreciation is included)
C. Fixed vs. Variable
2 kinds of input companies use
Fixed variable: one that cannot be varied as output changes
variable input: can be varied as output changes
ex: students are output and # of teachers are input
as number of students changes then number of professors and classroom changes
classroom space? cannot build within 6 months- fixed variable
fixed cost: cost of all fixed inputs
variable cost: cost of al variable input
ex: classroom space- suppose NYU decides to decrease some # of students