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Topic 5 Lecture Notes

Topic 5 Lecture Notes - Econ 1 ELEMENTS OF ECONOMICS 1...

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Econ 1 – ELEMENTS OF ECONOMICS 1 LECTURE NOTES Foster, UCSD 15-Oct-09 TOPIC 5 – PRODUCTION, COST & PROFIT A. Introduction to Cost and Profit 1. Private and Social Costs of Doing Business: a) Cost of production refers to the opportunity costs of resources used in production. 1) Typically measured in $ spent on resource inputs. 2) This $cost ≈ value of other goods and services which resources could have produced. b) Relevant levels of costs. 1) Private costs – relevant to decision makers in the firm 2) External costs – imposed on other members of society without compensation. 3) Social costs = private + external cost – relevant to society as a whole 2. Explicit and Implicit (Private) Cost: a) Explicit -- Actual payment that appears on the firm's books. b) Implicit or imputed -- The opportunity cost of resources already owned by (the owners of) the firm . No actual payment or transaction involved. Includes depreciation. 3. Profit (π): a) Profit -- TR − TC, the residual payment to owners of firm to compensate them for the use of their resources and for undertaking the risks of production (payment to entrepre- neurship). b) Names for π in the business world. 1) Single-owner proprietorship. π is proprietor's income taxed as personal income 2) Partnership. π is partners' income taxed as the personal income of each partner. 3) Corporation. π is allocated among corp π tax, dividends to stockholders, and retained earnings Stockholders own a corporation; their π = dividends + capital gains c) Types of profit. 1) Accounting profit: π a = TR − Explicit Cost 2) Pure economic profit: π e or π = TR − Expl. − Impl. Cost 3) Normal profit: π n ≈ Implicit Cost π e = π a − π n or π a = π n + π e
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Ec 1 PRODUCTION/COST/PROFIT p. 2 d) Profits and business decisions. 1) π a is income to owners from operating the business; π n is income the owners need to be willing to continue operating this business instead of putting their resources to work in the best alternative open to them. 2) If π a > π n , then π e > 0. Owners make more in this business than in best alternative. They will stay in business, and maybe expand. 3) If π a = π n , then π e = 0, and the owners are "breaking even" in the economic sense . They are making as much as in next best alternative. They will stay in business. 4) If π a < π n , then π e < 0. The owners are losing money relative to their best alternative. (They may have a positive income, but it is not as large as the one they could have in some other line of work.) If the owners expect π e < 0 for a long time, they will want to get out of this business and into a more profitable alternative. 4. Example of Cost and Profit Calculations: a) The setting. Your firm sells 500 widgets/yr. You used your own money to buy capital equipment costing $4,000 with a life span of 5 years. Using straight line depreciation, you put aside a depreciation allowance of $800/yr (1/5 of $4000). The market interest rate is 10%/yr; you could make $400/yr in interest if you didn't have $4,000 tied up in undepreciated capital equipment and accumulated depreciation allowances.
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Topic 5 Lecture Notes - Econ 1 ELEMENTS OF ECONOMICS 1...

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