Econ501aL10

# Econ501aL10 - Costs Accounting Cost{stresses\out of pocket...

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Costs Accounting Cost{stresses \out of pocket" expenses. Depreciation costs are based on tax laws. Economic Cost{based on opportunity cost (the next best use of resources). 1. A self-employed entrepreneur's economic cost in- cludes the opportunity cost of his time (the wage he could have received elsewhere). 2. A ¯rm's economic cost includes its cost of capital, even if the ¯rm owns the capital.

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Example: Say you bought a building last year, and paid \$1,000,000. Suppose the current market value is \$800,000, the interest rate is i , and the rental rate is r . (ignore depreciation) Then the economic cost of the building for this year is i ¢ 800 ; 000 = r ¢ 800 ; 000. One alternative to owning the building is selling it and buying a bond, receiving i ¢ 800 ; 000. Another alternative is renting the building to someone else, and receiving r ¢ 800 ; 000. The price of capital is r = i .I f r>i ,e v e r y on e should borrow the money to buy their capital instead of renting. If i>r , everyone should sell their capital andrentitback .
Cost Minimization: the Importance of Marginal Analysis Plant 1: 1000 workers, produce 10,000 widgets Plant 2: 500 workers, produce 4000 widgets A consultant is hired, who reasons as follows. AP L (1) = 10 and AP L (2) = 8. Therefore, the ¯rm should send workers from plant 2 to plant 1, where they will be more productive. What should the ¯rm do? Fire the consultant. To know whether workers are allocated e±ciently, we need to know about marginal products. For example, if MP L (1) = 10 and L (2) = 15, send a worker from plant 1 to plant 2, for a net gain of 5 widgets.

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Cost Minimization (Long Run) Here we solve the problem of how to produce a given amount of output at the minimum cost.
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Econ501aL10 - Costs Accounting Cost{stresses\out of pocket...

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