The Costs of Production
ANSWERS TO END-OF-CHAPTER QUESTIONS
Distinguish between explicit and implicit costs, giving examples of each.
What are the explicit
and implicit costs of attending college?
Why does the economist classify normal profit as a cost?
Is economic profit a cost of production?
Explicit costs are payments the firm must make for inputs to nonowners of the firm to attract
them away from other employment, for example, wages and salaries to its employees.
costs are nonexpenditure costs that occur through the use of self-owned, self-employed resources,
for example, the salary the owner of a firm forgoes by operating his or her own firm and not
working for someone else.
The explicit costs of going to college are the tuition costs, the cost of books, and the extra costs of
living away from home (if applicable).
The implicit costs are the income forgone and the hard
grind of studying (if applicable).
Economists classify normal profits as costs, since in the long run the owner of a firm would close
it down if a normal profit were not being earned. Since a normal profit is required to keep the
entrepreneur operating the firm, a normal profit is a cost.
Economic profits are not costs of production since the entrepreneur does not require the gaining
of an economic profit to keep the firm operating. In economics, costs are whatever is required to
keep a firm operating.
Gomez runs a small pottery firm.
He hires one helper at $12,000 per year, pays
annual rent of $5,000 for his shop, and spends $20,000 per year on materials.
He has $40,000 of
his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him
$4,000 per year if alternatively invested.
He has been offered $15,000 per year to work as a
potter for a competitor.
He estimates his entrepreneurial talents are worth $3,000 per year.
annual revenue from pottery sales is $72,000.
Calculate accounting profits and economic profits
for Gomez’s pottery.
$37,000 (= $12,000 for the helper + $5,000 of rent + $20,000 of materials).
$22,000 (= $4,000 of forgone interest + $15,000 of forgone salary + $3,000 of
Accounting profit = $35,000 (= $72,000 of revenue - $37,000 of explicit costs); Economic profit
= $13,000 (= $72,000 - $37,000 of explicit costs - $22,000 of implicit costs).
Which of the following are short-run and which are long-run adjustments?
(a) Wendy’s builds a
new restaurant; (b) Acme Steel Corporation hires 200 more production workers; (c) A farmer
increases the amount of fertilizer used on his corn crop; and (d) An Alcoa plant adds a third shift