ch 7_Econ 281_Fall_2010 - 1. 2. InputDemands 3. Accounting...

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 1. Implicit and explicit costs 2.   Long Run Cost Minimization The constrained minimization problem Input Demands 3.   Short Run Cost Minimization
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Accounting costs Accounting costs: explicit costs (direct monetary outlays) PLUS accounting depreciation Accounting depreciation is the fall in the value of the firm’s capital, and accountants calculate it relying on Canada Revenue Agency information (which relies on the historical series of prices)
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Economic costs Economic costs =Explicit Costs PLUS Implicit Costs Explicit costs : direct monetary outlays (expenses) Implicit costs : economic depreciation and opportunity cost Economic depreciation: the opportunity cost of a firm using capital that it owns—measured as the change in the market value of capital over a given period (that is, the current market price of what the firm currently owns matched against the price the firm paid for it) Opportunity Cost: The highest-valued alternative forgone is the opportunity cost of a firm’s production
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Opportunity Cost Example: You start an internet company. Say you could have earned $55,000 as salesman instead of starting your own business or teach at a high school for $40,000 Then $55,000 is the opportunity cost of starting your internet company The opportunity cost is the highest-valued alternative forgone
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PROFITS Accounting profit Total revenue minus accounting costs Economic profit Total revenue minus economic costs
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Example You start an internet company. Say, you could have earned $55,000 as salesman (opportunity cost). The first year you have earn $100,000 of revenues and paid $50,000 to your only employee. The market value of your computers (after one year of usage) makes a total of $17,000 versus the $25,000 you paid them. The economic depreciation is $8,000. Instead, the value of the computers for your accountant is $22,000 for a depreciation of $3,000. What is your economic profit? $-13,000=$100,000-$8,000-$50,000-$55,000 You suffer an economic loss What is your accounting profit? $47,000=$100,000-$3,000-$50,000
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From now on, we will focus mostly on production processes that utilize two inputs Labour (L) and Capital (K) We will be concerned only with the explicit costs of Labour and Capital Why? Adding opportunity cost analysis would complicate the exposition too much, and there is the problem that it is intangible. Note: From now on, w denotes the price of a unit of labour (flow) and r denotes the price of a unit of capital (flow)
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The ISOCOST line is the set of combinations of K and L that cost a given amount. TC = rK + wL …or… (TC stands for Total Cost) K = TC 0 /r – (w/r)L …is the isocost line Slope: -(w/r) (negative) Intercept: TC 0 /r (positive) Example: say r = $1 and w = $7 Then the isocost line corresponding to a Total Cost of $100 is 100 = 1K + 7 L or K= -7L +100 ISOCOST LINE
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L K TC 0 /w TC 1 /w TC 2 /w TC 2 /r TC 1 /r TC 0 /r Slope = -w/r Direction of DECREASE in total cost Isocost Lines
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This note was uploaded on 10/04/2011 for the course ECONOMICS 281 taught by Professor Vg during the Spring '09 term at University of Alberta.

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ch 7_Econ 281_Fall_2010 - 1. 2. InputDemands 3. Accounting...

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