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Chapter-08 - Chapter Objectives Chapter 8 Explicit and...

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10/11/2010 1 Chapter 8 THE COSTS OF PRODUCTION Chapter Objectives circle5 Explicit and implicit costs circle5 Law of diminishing returns circle5 Fixed and variable costs circle5 Total, average, and marginal costs circle5 The firm’s size in the long run 8-2 Economic Costs circle5 For economists, economic costs are explicit payments to the factors of production plus the opportunity cost of the factors provided by the owners of the firm. circle5 Explicit costs ring2 Monetary payments circle5 Implicit costs ring2 Value of next best use ring2 Self-owned resources ring2 Self-employed resources ring2 No monetary payments 8-3 Firms Maximize Profit circle5 Accountants focus on explicit costs and revenues Accounting profit = revenue – explicit cost Economists and accountants measure profit differently Economists focus on both explicit and implicit costs and revenue Economic profit = revenue – (explicit and implicit cost) 12-4 Numerical example Total sales revenue $120,000 Cost of T-shirt $40,000 Clerk’s salary 18,000 Utilities 5,000 Total explicit costs 63,000 Accounting profits 57,000 Accounting profits $57,000 Forgone interest $ 1,000 Forgone rent 5,000 Forgone wages 22,000 Forgone entrepreneurial income 5,000 Total implicit costs 33,000 Economic profit 24,000 Suppose you are earning $ 22,000 a year as a sales representative for a T-shirt manufacturer. You open a retail store (T-Shirts). You invest $20,0o0 of savings that have been earning you $ 1,000 per year. You use a store that you own and have been renting for $5,000 per year. You hire a clerk with a salary of $ 18,000 per year. Explicit Costs ($63,000) Implicit Costs (33,000) Economic Costs Revenue Accounting Profits Normal Profits Economic Profits Profits Compared $ 1 2 0 , 0 0 0
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10/11/2010 2 The Production Process A firm chooses from all possible production techniques All inputs are variable Firms enter and exit The production process can be divided into the long run and the short run The terms long run and short run do not necessarily refer to specific periods of time, but to the flexibility the firm has in changing the level of output Short run Long run A firm is constrained in regard to what production decisions it can make Some inputs are fixed (i.e.
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