THE COSTS OF PRODUCTION
– In this chapter students will learn:
A. Why economic costs include both explicit (revealed and expressed) costs and implicit
(present but not obvious) costs.
How the law of diminishing returns relates to a firm’s short-run production costs.
The distinctions between fixed and variable costs and among total, average, and marginal
D. The link between a firm’s size and its average costs in the long run.
Economic costs are the payments a firm must make, or incomes it must provide, to
resource suppliers to attract those resources away from their best alternative production
Payments may be explicit or implicit.
(Recall opportunity-cost concept in
A. Explicit costs are payments to nonowners for resources they supply.
In the text’s example
this would include cost of the T-shirts, clerk’s salary, and utilities, for a total of $63,000.
Implicit costs are the money payments the self-employed resources could have earned in
their best alternative employments.
In the text’s example this would include forgone interest,
forgone rent, forgone wages, and forgone entrepreneurial income, for a total of $33,000.
Normal profits are considered an implicit cost because they are the minimum payments
required to keep the owner’s entrepreneurial abilities self-employed.
This is $5,000 in the
D. Economic or pure profits are total revenue less all costs (explicit and implicit including a
Figure 8.1 illustrates the difference between accounting profits and economic
The economic profits are $24,000 (after $63,000 + $33,000 are subtracted from
The short run is the time period that is too brief for a firm to alter its plant capacity.
plant size is fixed in the short run.
Short-run costs, then, are the wages, raw materials, etc.,
used for production in a fixed plant.
The long run is a period of time long enough for a firm to change the quantities of all
resources employed, including the plant size.
Long-run costs are all costs, including the cost
of varying the size of the production plant.
Short-Run Production Relationships
A. Short-run production reflects the law of diminishing returns that states that as successive
units of a variable resource are added to a fixed resource, beyond some point the product
attributable to each additional resource unit will decline.
Consider This … Diminishing Returns from Study
Table 8.1 presents a numerical example of the law of diminishing returns.