Teaching notes 8.pdf - BUSINESSES AND THE COSTS OF PRODUCTION I Total Revenue Total Cost and Profit A The goal of a firm is to maximize profit B

Teaching notes 8.pdf - BUSINESSES AND THE COSTS OF...

This preview shows page 1 - 3 out of 7 pages.

1 BUSINESSES AND THE COSTS OF PRODUCTION I. Total Revenue, Total Cost, and Profit A. The goal of a firm is to maximize profit. B. Definition of total revenue: the amount a firm receives for the sale of its output. C. Economic costs are 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. D. Costs as Opportunity Costs: The cost of something is what you give up to get it. 1. The costs of producing an item must include all of the opportunity costs of inputs used in production. 2. Total opportunity costs include both implicit and explicit costs. a. Definition of explicit costs: input costs that require an outlay of money by the firm . They are payments to non-owners for resources they supply. b. Definition of implicit costs: input costs that do not require an outlay of money by the firm . They are the money payments the self-employed resources could have earned in their best alternative employments, like forgone interest, forgone rent, forgone wages, and forgone entrepreneurial income. c. The total cost of a business is the sum of explicit costs and implicit costs. 3. The Cost of Capital as an Opportunity Cost a. The opportunity cost of financial capital is an important cost to include in any analysis of firm performance. b. Example: Helen uses $300,000 of her savings to start her firm. It was in a savings account paying 5% interest. c. Because Helen could have earned $15,000 per year on this savings, we must include this opportunity cost. (Note that an accountant would not count this $15,000 as part of the firm's costs.) d. If Helen had instead borrowed $200,000 from a bank and used $100,000 from her savings, the opportunity cost would not change if the interest rate stayed the same (according to the economist). But the accountant would now count the $10,000 in interest paid for the bank loan. E. Economic Profit versus Accounting Profit 1. Definition of economic profit: total revenue minus total cost, including both explicit and implicit costs . a. Economic profit is what motivates firms to supply goods and services. b. To understand how industries evolve and to detect anticompetitive environments, we need to examine economic profit. 2. Definition of accounting profit: total revenue minus total explicit cost . 3. If implicit costs are greater than zero, accounting profit will always exceed economic profit. II. Short-Run Production Relationships Total Revenue = Price Quantity
Image of page 1

Subscribe to view the full document.

2 A. The short run is the time period when at least one input is fixed For instance, when it 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.
Image of page 2
Image of page 3

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask bonus questions You can ask questions ( expire soon) You can ask questions (will expire )
Answers in as fast as 15 minutes