L8 - Production and Costs-BB-1

# L8 - Production and Costs-BB-1 -...

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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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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 Note: 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.
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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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.
Class Exercise Class Exercise :    :    Economic profit vs. accounting profit Economic profit vs. accounting profit 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 5

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Answers Answers 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. 6
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. Example 1: Farmer Jack grows wheat. He has 5 acres of land. He can hire as many workers as he wants.

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0 500 1,000 1,500 2,000 2,500 3,000 0 1 2 3 4 5 No. of workers Quantity of output EXAMPLE 1:   Farmer Jack’s Production Function 3000 5 2800 4 2400 3 1800 2 1000 1 0 0 Q (bushels of wheat) L (no. of workers)
Marginal Product The marginal product of any input is the increase in output arising from an additional unit of that input, holding all other inputs constant.

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## This note was uploaded on 12/02/2011 for the course ECON 200 taught by Professor Vincent during the Fall '08 term at Maryland.

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L8 - Production and Costs-BB-1 -...

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