Class 8s - Department of Economics LeBow College of...

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Department of Economics Fall 2009 LeBow College of Business Economics 301 Drexel University Professor Stehr Class 8 Outline 1) Total cost and opportunity cost 2) Short run costs 3) Long run costs Economic profit (hereafter called just profit) = Total revenue – Total cost Total revenue is price * quantity Costs structure of firm Opportunity Cost – cost associated with opportunities that are foregone when a firm’s resources (such as inputs or assets) are not put to their next best use. Total cost includes “Regular” or explicit costs -- Implicit or opportunity costs Financial capital— Inputs—value of whatever else an input could have been used for Ex1: opportunity cost of owning property and residing at ground level in Midtown Manhattan is that you can’t rent out the space commercially. Since the opportunity cost is so high, nobody would choose to do this. Ex2: entrepreneur gives up wages of old job when starting up a business The opportunity cost of financial capital is measured by the normal rate of return. The interest rate on US government bonds is often used as the normal rate of return because it is considered less risky than any other investment. Hence, no adjustment to the interest rate is necessary to compensate for the risk of default. 1
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Suppose a large company has 100 million dollars and is trying to decide whether to undertake a new project. If the firm undertakes the project, it will incur 100 million dollars in explicit costs in one year and the project will generate 105 million dollars in revenue in one year. Alternatively, the firm could buy government bonds at an interest rate of 6.0% per year.
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Class 8s - Department of Economics LeBow College of...

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