Chapter7(1)

Chapter7(1) - The Cost of Production Chapter 7 Chapter...

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The Cost of Production Chapter 7
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Chapter Outline Measuring Cost: Which Costs Matter? Cost in the Short Run Cost in the Long Run Optimal choice of input combinations
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MEASURING COST: WHICH COSTS MATTER? Economic Cost versus Accounting Cost accounting cost: actual expenses plus depreciation charges for capital equipment economic cost: cost to a firm of utilizing economic resources in production, including opportunity cost Opportunity cost: cost associated with opportunities that are forgone when a firm’s resources are not put to their best alternative use
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The equilibrium rent on office space has just increased by $500/month. Compare the effects on accounting cost (hence accounting profit) and economic cost (hence 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 Economic cost vs. accounting cost Economic cost vs. accounting cost 4
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MEASURING COST: WHICH COSTS MATTER? s unk cos t Expenditure that has been made and cannot be recovered. Because a sunk cost cannot be recovered, it should not influence the firm’s decisions. For example, consider the purchase of specialized equipment for a plant. Suppose the equipment can be used to do only what it was originally designed for and cannot be converted for alternative use. The expenditure on this equipment is a sunk cost. Because it has no alternative use, its opportunity cost is zero . Thus it should not be included as part of the firm’s economic costs.
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The 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 makes the common mistake of failing to appreciate opportunity costs. From an economic point of view, it is very expensive to locate 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. Choosing the Location for a New Law School Building
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You need $100,000 to start your business. The interest rate is 5%. Case 1: borrow $100,000 accounting cost = economic cost = Case 2: use $40,000 of your savings, borrow the other $60,000 accounting cost = economic cost = 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 Economic cost vs. accounting cost Economic cost vs. accounting cost
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Case 1: borrow $100,000 accounting cost = $5000 interest on loan
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Chapter7(1) - The Cost of Production Chapter 7 Chapter...

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