Unit 5 - Cost Functions

1. 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

2. Which of the following comes closest to the true economic cost (on average) of earning a bachelor’s degree in college? • $10,000 • $20,000 • $40,000 • $60,000 • $160,000 0 of 5

3. 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

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

5. 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: • $5,000; $25,000 • $5,000; $30,000 • $30,000; 5,000 • $30,000; $25,000 • $75,000; $80,000

6. 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

7. 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

8. 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 = $10,000From a financial point of view, should the firm continue to operate? Microeconomics

9. 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

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

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

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

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

14. Unit 5 - Cost Functions • Total and Per Unit Costs Example 3If 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

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

16. Unit 5 - Cost Functions • Total and Per Unit Costs Example 4Using 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

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

18. Unit 5 - Cost Functions • Cost CalculationsExample 5 - Fill in the missing values Microeconomics

19. Unit 5 - Cost Functions • Short-run Cost CalculationsExample 5 answer Microeconomics

20. Unit 5 - Cost Functions • The Shape of Typical Cost Curves Costsin Dollars MC ATC AVC Quantity Produced

21. Unit 5 - Cost Functions • The Long-run Average Cost CurveIn 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

22. Unit 5 - Cost Functions • The Long-run Average Cost Curve 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). Average Costs EOS DOS Quantity Produced Microeconomics

23. 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). ExampleInputs increase by 10%, and production increases by 20%. Microeconomics

24. 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). ExampleInputs increase by 10%, and production increases by 5%. Microeconomics

25. 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. ExampleInputs increase by 10%, and production increases by 10%. Microeconomics