L13costfcns - Lecture 13 Cost Functions Key Terms in...

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Lecture 13: Cost Functions
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Key Terms in Lecture Opportunity cost Accounting cost Economic cost Economic profit Contingent/Derived demand for inputs Expansion path Total cost Average cost Marginal cost Short-run and long-run costs
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Opportunity Cost Let’s recall what opportunity cost means: The opportunity cost of an action (e.g. hiring a factor of production) is the value of the best alternative that must be forgone when the action is taken (e.g. the amount of income the factor of production could earn in its best alternative form of employment)
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Definitions of Costs It is important to differentiate between accounting cost and economic cost – The accountant’s view of cost stresses out-of- pocket expenses, historical costs, depreciation, and other bookkeeping entries – Economists focus on opportunity cost Economic cost = opportunity cost: The economic cost of any input is the payment required to keep that input in its present employment – the remuneration the input would receive in its best alternative employment
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Definitions of Costs: Labor Labor Costs (dealt with similarly) to economists (typically): labor services are contracted at an hourly wage ( w ) (typically) it is assumed that this is also what the labor could earn in alternative employment In this case, economic labor cost and accounting labor cost coincide You don’t need to know this: If, however, a worker earns strictly more at one firm (or in one industry) than in any other, we say that the worker is earning “rents” (the excess earnings over her opportunity cost) If you know something about your boss, you can earn rents in the firm (you’ll earn more in the firm than anywhere else) This is one big difference between countries with good and bad institutions: in countries with good institutions, you push up your wage by increasing your opportunity cost; in countries with bad institutions you try to extract rents.
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Definitions of Costs Capital Costs (different) – accountants use the historical price of the capital and apply some depreciation rule to determine current costs – economists refer to the capital’s original price as a “sunk cost” instead regard the implicit cost of the capital to be what someone else would be willing to pay for its use (opportunity cost) we will use v or r to denote the rental rate for capital – The book uses v while everyone else uses r
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Definitions of Costs Costs of Entrepreneurial Services For accountants, the firm owner’s profits are revenues or losses left over after paying all input costs Economists consider the opportunity costs of time and funds that owners devote to the operation of their firms Economic profit is accounting profit minus the opportunity costs of time and funds that owners devote to the operation of their firms If you could earn $100,000 at Cisco but instead start your own firm (without adding your own capital) and have accounting
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