M607-W10-Chapter_07

M607-W10-Chapter_07 - 7-1Chapter 7.CostsMSci 607: Applied...

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Unformatted text preview: 7-1Chapter 7.CostsMSci 607: Applied economics for management (winter 2010)Instructor: Bon KooThe production function discussed in the previous chapter summarizes (many) technologically efficient production processes available. Then, the next question is how to pick one production process (out of many) which is economically efficient, i.e., minimizing the cost of producing outputs. This chapter discusses various issues of costs and the selection of efficient production. 7-21. Basics of costs: Economic costEconomic cost = Explicit cost + Implicit costExplicit cost: Direct payments for salaries or materialsImplicit cost: Value of inputs that do not have market price or were purchased before.Opportunity costThis cost is the value of the best alternative use of a resource. The implicitopportunity cost is the most important concept in business environment, but many people are confused.Suppose you quit a job which pays $50,000/year, and started your own business. At the end of the year, your total revenue is $100,000 and the explicit cost (rent, wage, materials, etc.) is $60,000. Are you happy to make a $40,000 of profit?oYou forgot to add your opportunity cost of labor. The very alternative of your labor brings you $50,000, so you should add this opportunity cost in your profit calculation. oYour economic profit is negative ($10,000) after considering this implicit cost.Suppose you opened your own business at your fathers building and your father agreed not to charge rents to you. What is the implicit opportunity cost?oIn your profit calculation, you should add the amount of rent if it were to rent to ot7-31. Basics of costs: Economic costThe Northwestern University Law School has been located in Chicago. However, the main campus is located in the suburb of Evanston. In the mid-1970s, the law school began planning the construction of a new building and needed to decide on an appropriate location.Should it be built on the current site, near downtown Chicago law firms? Should it be moved to Evanston, physically integrated with the rest of the university?Some argued it was cost-effective to locate the new building in the city because the university already owned the land. Land would have to be purchased in Evanston if the building were to be built there. Does this argument make economic sense?No. It is making the common mistake of failing to appreciate opportunity costs. From an economic point of view, it is very expensive to locate the law school downtown because the property could have been sold for enough money to buy the Evanston land with substantial funds left over. Northwestern decided to keep the law school in Chicago.(Excerpted from Pindyck and Rubinfeld, 2008)7-41. Basics of costs: Capital costCapital cost: The cost of a durable good that is useable for yearsCapital cost is often fixed and sunkin the short run....
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This note was uploaded on 02/16/2010 for the course MTH 10 taught by Professor Gail during the Spring '10 term at 4.1.

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M607-W10-Chapter_07 - 7-1Chapter 7.CostsMSci 607: Applied...

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