chapter 9 notes - The Costs of Production CHAPTER NINE THE...

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The Costs of Production CHAPTER NINE THE COSTS OF PRODUCTION LECTURE NOTES I. 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 2.) 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 9-1 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 time period 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. II. 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 9-1 presents a numerical example of the law of diminishing returns. 3. Total product (TP) is the total quantity, or total output, of a particular good produced. 4. Marginal product (MP) is the change in total output resulting from each additional input of labor. 5. Average product (AP) is the total product divided by the total number of workers.
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