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Chapter 8 notes

Chapter 8 notes - The Costs of Production CHAPTER EIGHT THE...

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The Costs of Production CHAPTER EIGHT THE COSTS OF PRODUCTION LECTURE NOTES I. Learning objectives – In this chapter students will learn: A. Why economic costs include both explicit (revealed and expressed) costs and implicit (present but not obvious) costs. B. How the law of diminishing returns relates to a firm’s short-run production costs. C. The distinctions between fixed and variable costs and among total, average, and marginal costs. D. The link between a firm’s size and its average costs in the long run. II. 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 opportunities. Payments may be explicit or implicit. (Recall opportunity-cost concept in Chapter 1.) 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. B. 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. C. 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 example. D. Economic or pure profits are total revenue less all costs (explicit and implicit including a normal profit). Figure 8.1 illustrates the difference between accounting profits and economic profits. The economic profits are $24,000 (after $63,000 + $33,000 are subtracted from $120,000). E. The short run is the time period that is too brief for a firm to alter its plant capacity. The 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. F. 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. III. 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. 1. Example: Consider This … Diminishing Returns from Study 2. Table 8.1 presents a numerical example of the law of diminishing returns.
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