EconH200L9

EconH200L9 - Costs of Production What decisions lie behind...

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Costs of Production What decisions lie behind the supply curve, and why is the supply curve upward sloping? Obviously, costs are crucial. We will begin by discussing opportunity cost in more detail, and distinguishing between economic costs and accounting costs. Next we will consider a firm’s technology for transforming inputs into outputs. This technology is quantified by a production function. Then we will derive a firm’s total cost function, based on the prices of inputs and the production function. In the next chapter, we will see how a firm’s cost function, and the price of its output, determine its profit maximizing quantity supplied.
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What is the main objective of Helen’s Cookies? To make cookie lovers happy, to enjoy the cookie business, or to make profit? Economists usually assume that firms seek to maximize profits, and this assumption works well for most firms. In a competitive industry, maximum profits are very low, so any sacrifice of profits for other objectives might force the firm out of business. Profit = Total Revenue - Total Cost. Total revenue is price × quantity. Measuring total cost can be tricky. There is a difference between “economic profits” and “accounting profits.”
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Costs of production include all opportunity costs, everything that a firm gives up in order to produce. Explicit “out of pocket” expenses are opportunity costs, because the money could have been used to buy something else. (For example, $1000 for flour or $2000 in wages) Some opportunity costs are implicit. For example, if Helen could have earned $100 per hour as a computer programmer or cookie consultant. If the wage Helen would receive as a programmer increases from $100 to $500 per hour, her accounting costs are unchanged, but to an economist the cost of running her cookie business has gone up. Maybe she should shut down the business and become a programmer.
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The Cost of Capital Suppose Helen used $300,000 of her savings to buy her cookie factory. If the interest rate is 5%, she is giving up the opportunity to earn $15,000 per year in interest. Even though she owns the factory free and clear, she incurs the cost, because she could instead sell the factory and earn $15,000 per year. Helen’s capital costs are the interest rate multiplied by the value of the capital, whether the capital is owned or not. If instead Helen used $100,000 of her money and $200,000 of borrowed money to buy the factory, explicit costs per year are $10,000 and implicit costs are $5,000 per year.
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EconH200L9 - Costs of Production What decisions lie behind...

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