HUTECH Institute of International Education Cost of production COST OF PRODUCTION 6 1 WHAT ARE COSTS? 6 2 PRODUCTION AND COSTS 6 3 VARIOUS MEASURE OF COSTS 6 4 COST IN SHORT RUN AND LONG RUN HUTECH In[.]
COST OF PRODUCTION 6.1 WHAT ARE COSTS? 6.2 PRODUCTION AND COSTS 6.3 VARIOUS MEASURE OF COSTS 6.4 COST IN SHORT-RUN AND LONG-RUN HUTECH Institute of International Education Cost of production Total Revenue, Total Cost, Profit ▪ 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 Total revenue = P*Q HUTECH Institute of International Education Cost of production Costs: Explicit vs Implicit ▪ Explicit costs require an outlay of money, which are actually paid by the firm e.g., paying wages to workers, lease payment, cost of raw materials… ▪ Implicit costs opportunity costs of resources owned and used by the firm but not actually paid for by the firm e.g., opportunity cost of the owner’s time or labor, ▪ Both matter for firms’ decisions HUTECH Institute of International Education Cost of production Explicit vs Implicit Costs: An Example You need $100,000 to start your business, i=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 (explicit + implicit) costs are $5000 HUTECH Institute of International Education Cost of production 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 HUTECH Institute of International Education Cost of production Profit Example Suppose an individual runs his own business with the following revenue and costs for the year: •Sales Revenue: $800,000 •Cost of Materials, Rent and Labour: $750,000 •Salary Foregone: $60,000 (opportunity cost) Calculate: Accounting Profit ? Economic Profit ? HUTECH Institute of International Education Cost of production Profit Example Accounting Profit? = $50,000 (= $800,000 - $750,000) Economic Profit? = $800,000 - $750,000 - $60,000 = -$10,000 (=.= He made an economic loss) HUTECH Institute of International Education Cost of production Summary of Cost and Profit Profits to an accountant Economic (opportunity) costs Profits to an economist Economic profits Implicit costs (including a normal profit) Explicit Costs HUTECH Institute of International Education Accounting profits Total Revenue Accounting costs (explicit costs only) Cost of production 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 • Analysis in short run HUTECH Institute of International Education Cost of production Example 1: Farmer Jack’s Production Function Q (no of (bushels workers) of wheat) 3,000 Quantity of output L 2,500 0 1000 1800 2400 500 2800 3000 HUTECH Institute of International Education 2,000 1,500 1,000 No of workers Cost of production ... •Salary Foregone: $60 ,000 (opportunity cost) Calculate: Accounting Profit ? Economic Profit ? HUTECH Institute of International Education Cost of production Profit Example Accounting Profit? = $50,000... Economic Profit? = $800,000 - $750,000 - $60 ,000 = -$10,000 (=.= He made an economic loss) HUTECH Institute of International Education Cost of production Summary of Cost and Profit Profits to an... implicit) costs are $5000 HUTECH Institute of International Education Cost of production Economic Profit vs Accounting Profit ▪ Accounting profit = total revenue minus total explicit costs ▪ Economic