Lecture 5 notes - Chapter 13 The Costs of Production I....

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Costs: Lecture Review What Are Costs? Economists generally assume that the goal of a firm is to maximize profits . Profit = total revenue – total cost. Total revenue is the quantity of output the firm produces times the price at which it sells the output. Total cost is more complex. An economist considers the firm’s cost of production to include all of the opportunity costs of producing its output. The total opportunity cost of production is the sum of the explicit and implicit costs of production. Explicit costs are input costs that require an outlay of money by the firm, such as when money flows out of a firm to pay for raw materials, workers’ wages, rent, and so on. Implicit costs are input costs that do not require an outlay of money by the firm. Implicit costs include the value of the income forgone by the owner of the firm had the owner worked for someone else plus the forgone interest on the financial capital that the owner invested in the firm. Accountants are only concerned with the firm’s flow of money so they record only explicit costs. Economists are concerned with the firm’s decision making so they are concerned with total opportunity costs, which are the sum of explicit costs and implicit costs. Since accountants and economists view costs differently, they view profits differently: Economic profit = total revenue – (explicit costs + implicit costs), Accounting profit = total revenue – explicit costs. Because an accountant ignores implicit costs, accounting profit is greater than economic profit. The big business scandals of 2001 and 2002 begin with the fraudulent measurement of revenue, costs, and therefore profit. The result was inflated stock prices and inflated values of stock options owned by corporate executives. Production and Costs For the following discussion, we assume that the size of the production facility (factory) is fixed in the short run. Therefore, this analysis describes production decisions in the short run. BE 530 Page 1 of 4 Mercedes Miranda
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A firm’s costs reflect its production process. A production function shows the relationship between the quantity of inputs used to make a good (horizontal axis) and the quantity of output of that good (vertical axis). The marginal product of any input is the increase in output that arises from an additional unit of that input. The marginal product of an input can be measured as the slope of the production function or "rise over run." Production functions exhibit diminishing marginal product —the property whereby the marginal product of an input declines as the quantity of the input increases. Hence, the slope of a production function gets flatter as more and more inputs are added to the production process. The total cost curve shows the relationship between the quantity of output produced and the total cost of production. Since the production process exhibits diminishing marginal product, the quantity of inputs necessary to produce equal increments of output rises as we produce more output and, thus, the total cost
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This note was uploaded on 07/15/2011 for the course ACC 360 taught by Professor Marshallhunt during the Spring '09 term at University of Michigan-Dearborn.

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Lecture 5 notes - Chapter 13 The Costs of Production I....

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