Unit 5 - Cost Functions • Explicit Costs and Implicit Costs Explicit cost are out-of-pocket expenses, such as labor, raw materials, and rent.

Implicit costs are foregone expenses, such as the value of your own time, and the value of your own money (interest earned).

Microeconomics

Which of the following comes closest to the true economic cost (on average) of earning a bachelor’s degree in college?

1.

$10,000 2.

$20,000 3.

$40,000 4.

$60,000 5.

$160,000

0 of 5

Unit 5 - Cost Functions Estimated explicit costs of attending college (4 years): tuition, fees, books, and transportation: $15,000 x 4 = $60,000 .

Estimated implicit costs include foregone earnings, and foregone interest: $25,000 x 4 = $100,000.

Total economic cost: $160,000.

Microeconomics

Unit 5 - Cost Functions • Economic versus Accounting Profits Economic profits equal total revenue minus all (explicit and implicit) costs.

Accounting profits equal total revenue minus explicit costs.

Microeconomics

If a firm’s total revenue is $80,000, and its explicit and implicit costs are $50,000 and $25,000, respectively, then its economic and accounting profits are: 1.

$5,000; $25,000 2.

$5,000; $30,000 3.

$30,000; 5,000 4.

$30,000; $25,000 5.

$75,000; $80,000

Unit 5 - Cost Functions • Economic versus Accounting Profits Calculations Economic Profit = $80,000 - $75,000 = $5,000 Accounting Profit = $80,000 - $50,000 = $30,000 Microeconomics

Unit 5 - Cost Functions • Economic versus Accounting Profits Example 2: If a firm’s total revenue is $80,000, and its explicit and implicit costs are $70,000 and $25,000, respectively, what are its economic and accounting profits?

Microeconomics

Unit 5 - Cost Functions • Economic versus Accounting Profits Example 2 answer Economic Profit = $80,000 - $95,000 = - $15,000 Accounting Profit = $80,000 - $70,000 continue to operate?

= $10,000 From a financial point of view, should the firm Microeconomics

• Unit 5 - Cost Functions Total and Per Unit Costs – – – – Total and per unit economic costs include: – Total Variable Cost (TVC) – – Total Fixed Cost (TFC) Total Cost (TC) Average Variable Cost (AVC) Average Fixed Cost (AFC) Average Total Cost (ATC) Marginal Cost (MC) Microeconomics

• Unit 5 - Cost Functions Total and Per Unit Costs Example 1 If TVC + TFC = TC, and TVC and TFC are $900 and $300, respectively, what is TC?

Microeconomics

Unit 5 - Cost Functions • Total and Per Unit Costs Example 1 answer Total Variable Cost Total Fixed Cost + Total Cost $900 $300 $1200 + Microeconomics

• Unit 5 - Cost Functions Total and Per Unit Costs Example 2 If TC is $1,200 and production is 50, what is ATC?

Microeconomics

Unit 5 - Cost Functions • Total and Per Unit Costs Example 2 answer ATC = TC Q = $1200 50 = $24 Microeconomics

Unit 5 - Cost Functions • Total and Per Unit Costs Example 3 If production is 50, and total variable and total fixed cost are $900 and $300, respectively, what are average variable cost and average fixed cost? (Output = 50).

Microeconomics

Unit 5 - Cost Functions • Total and Per Unit Costs Example 3 answer Average variable cost Average fixed cost = = $900 50 $300 =$6 50 =$18 Microeconomics

Unit 5 - Cost Functions • Total and Per Unit Costs Example 4 Using the data in the previous examples, let’s say that you produce an additional 5 products, and your total cost rises to $1260, what is your marginal cost?

Microeconomics

Unit 5 - Cost Functions • Total and Per Unit Costs Example 4 answer Marginal cost = change in total cost change in production = $60 = $12 5 Microeconomics

Unit 5 - Cost Functions • Cost Calculations Example 5 - Fill in the missing values Q TC TVC TFC ATC AVC AFC MC 0 1 2 3 4 80 80 110 70 90 Microeconomics

Unit 5 - Cost Functions • Short-run Cost Calculations Example 5 answer Q TC TVC TFC ATC AVC AFC MC 80 0 80 - - - - 0 1 2 3 4 160 80 80 160 80 220 140 80 110 70 380 300 80 95 75 80 40 80 60 290 210 80 96.7 70 26.7 70 20 90 Microeconomics

Unit 5 - Cost Functions • The Shape of Typical Cost Curves

Costs in Dollars MC ATC AVC Quantity Produced

Unit 5 - Cost Functions • The Long-run Average Cost Curve In the long run, all inputs are variable. A firm has enough time to choose the size of its factory, farm, office building, or other capital goods.

The firm can choose from many short-run cost curves. The bottom points of the short run average cost curves make up the long run average cost curve.

Microeconomics

Unit 5 - Cost Functions • The Long-run Average Cost Curve Average Costs EOS DOS Quantity Produced Long-run average costs fall as production first rises.

This is called economies of scale (EOS).

When the firm gets too big, long-run average costs rise. This is called diseconomies of scale (DOS).

Microeconomics

Unit 5 - Cost Functions • Returns to Scale When inputs increase, and production more than proportionately increases, then we speak of increasing returns to scale (associated with economies of scale).

Example Inputs increase by 10%, and production increases by 20%.

Microeconomics

Unit 5 - Cost Functions • Returns to Scale When inputs increase, and production less than proportionately increases, then we speak of decreasing returns to scale (associated with diseconomies of scale).

Example Inputs increase by 10%, and production increases by 5%.

Microeconomics

Unit 5 - Cost Functions • Returns to Scale When inputs increase, and production increases by the same percentage, then we speak of constant returns to scale.

Example Inputs increase by 10%, and production increases by 10%.

Microeconomics