Lecture for week 9 new - Lecture for week 9 This week we...

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Lecture for week 9 This week we will talk about production. We will develop some definitions and formulas and learn to use them. Next week we will talk about short run costs and the shapes of the cost curves in the short run. Profits Let us begin by talking about profits. Most firms are in the business to make money (profits). In economics we refer to profits as . Profits = = TR – TC, where TR is total revenue and TC is total cost. Total revenue is nothing but the money we make from sales. Total cost is what it costs to produce our product. One thing that we have to be very careful about is that economic costs are not the same as costs in accounting. In accounting, the only kind of costs that are recognized are costs of employing our inputs or factors of production. In other words, what we pay our labor, land, capital and so forth. In economics these costs are called explicit costs. In addition we also include in economics implicit costs. Implicit costs are nothing but opportunity costs. Let us take an example. Suppose you are thinking of starting a business. You have $50,000 to invest in this business. If you don’t start this business you would put this $50,000 in a bank where the money would earn, say, a 10% interest. So the interest would amount to $5000. Also if you don’t start this business you will keep your current job where you make $25,000 a year. If you do start the business, then you will need to pay $150,000 a year to your factors of production – land, labor and capital. These are your explicit costs. If you were to ask an accountant they would say your costs of running this business are $150,000.
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An economist on the other hand would say your total costs are not only the $150,000 of explicit costs but also your opportunity costs (or implicit costs) that you are giving up. Your implicit costs are the $25,000 job you are giving up + the $5000 interest income that you can no longer get. So implicit costs are $30,000 So accounting costs = explicit costs = $150,000 Economic costs = explicit costs + implicit costs = $150,000 + $30,000 = $180,000 When we use these costs to find profits, we have a distinction between accounting profits and economic profits. Accounting profits = TR – Accounting costs Economic profits = TR – economic costs Economic costs are always greater than accounting costs. So it is possible that while you are making an accounting profit, you are not making an economic profit. In this course when we talk of total costs (TC) we will always be referring to economic costs. And the profits we will refer to will be economic profits. So in our example above our TC = $180,000 Now suppose that in this business we have sales worth $200,000. So TR = $200,000 and Economic profits = = TR – TC = $200,000 - $180,000 = $20,000 > 0 and we are making a profit.
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