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Lecture_Chapter13 - Lecture Cost of Production(Chapter 13...

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Lecture: Cost of Production (Chapter 13)
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THE COSTS OF PRODUCTION 2 Total Revenue, Total Cost, Profit We assume that the firm’s goal is to maximize profit . Profit = Total revenue Total cost the amount a firm receives from the sale of its output the market value of the inputs a firm uses in production
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THE COSTS OF PRODUCTION 3 Costs: Explicit vs. Implicit Explicit costs require an outlay of money, e.g. , paying wages to workers. Implicit costs do not require a cash outlay, e.g. , the opportunity cost of the owner’s time. Remember one of the Ten Principles: The cost of something is what you give up to get it . This is true whether the costs are implicit or explicit. Both matter for firms’ decisions.
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THE COSTS OF PRODUCTION 4 Explicit vs. Implicit Costs: An Example You need $100,000 to start your business. The interest rate is 5%. Case 1: borrow $100,000 explicit cost = $5000 interest on loan Case 2: use $40,000 of your savings, borrow the other $60,000 explicit cost = $3000 (5%) interest on the loan implicit cost = $2000 (5%) foregone interest you could have earned on your $40,000. In both cases, total (exp + imp) costs are $5000.
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THE COSTS OF PRODUCTION 5 Economic Profit vs. Accounting Profit Accounting profit = total revenue minus total explicit costs Economic profit = total revenue minus total costs (including explicit and implicit costs) Accounting profit ignores implicit costs, so it’s higher than economic profit.
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The equilibrium rent on office space has just increased by $500/month. Compare the effects on accounting profit and economic profit if a. you rent your office space b. you own your office space A C T I V E  L E A R N I N G   A C T I V E  L E A R N I N G   2 2         Economic profit vs. accounting profit Economic profit vs. accounting profit 6
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The rent on office space increases $500/month. a. You rent your office space. Explicit costs increase $500/month. Accounting profit & economic profit each fall $500/month. b. You own your office space. Explicit costs do not change, so accounting profit does not change. Implicit costs increase $500/month (opp. cost of using your space instead of renting it), so economic profit falls by $500/month. A C T I V E  L E A R N I N G   A C T I V E  L E A R N I N G   2 2         Answers Answers 7
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THE COSTS OF PRODUCTION 8 The Production Function A production function shows the relationship between the quantity of inputs used to produce a good and the quantity of output of that good. It can be represented by a table, equation, or graph.
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