Cost Structures and Supply

2. Cost Structures and Supply 1. Inputs • All inputs to production may be classified into the Factors of Production: • Land • Labour • Capital • Enterprise When examining allocative efficiency (best use of resources to satisfy consumer wants) ALL costs must be identified • Explicit Costs: the costs of production paid to people outside of the business • Implicit Costs: (imputed costs) the cost of resources owned by the business. These may include accounting costs (eg: depreciation) or opportunity costs (owner’s labour)

3. Cost Structures and Supply 2. Economic and Accounting Costs Accounting Costsare the monetary costs of production Economic Costs are ALL costs to the business, both accounting costs and opportunity costs. This opportunity cost will also include the opp cost of the owner, defined as the minimum profit required to keep the business open in the long term. eg: Simon’s holiday business refurbishing scooters

4. Cost Structures and Supply 3. Economic Profit This is defined as the difference between a firm’s revenue and its economic costs • Normal Profit:revenue = costs, a firm is earning sufficient profit to stay open in the long term • Subnormal Profit:revenue < costs, a firm is earning less profit than expected and will close if this situation continues • Supernormal Profit:revenue > costs, a firm is earning greater than expected profits

5. MC Increasing returns Diminishing Returns Cost Structures and Supply 4a. Shape of the Cost Curves – Marginal Cost Marginal Cost: the extra cost of producing an additional unit of output Costs • MC initially falls, then rises (resembling a tick) • the downward slope represents increasing returns to scale : inputs are used more efficiently as ouput is increased (see short-run economies) Output • where MC starts to rise, diminishing returns are setting in. The Law of Diminishing Returns: As additional inputs are added to a fixed amount of another input, the additional output will eventually fall. eg: if more workers are employed while not increasing plant or machinery. Although output will increase, these increases will eventually get smaller with each additional worker. In the short term, there are always some factors that are fixed in supply In the long term, all inputs are variable.

6. eg: Large Firm Refurbishing Scooters 100 150 increasing returns 250 150 constant returns 400 125 diminishing returns 525 100 diminishing returns 625 75 diminishing returns 700

7. MC AC AVC Cost Structures and Supply 4b. Shape of the Cost Curves – Average Costs Average Variable Cost: production costs per unit Costs • AVC has a U-shape, and is derived from the MC curve • while MC is below AVC, it will fall • when MC is above AVC, it will rise • so the MC curve cuts the AVC curve at its lowest point (this is also the most efficient point of production) Output • Average Cost is also U-shaped and derived from MC with non-production costs (fixed costs) also included • the gap between AC and AVC represents average fixed costs so will get smaller as output is increased. Short-run economies and short-run diseconomies pg77 Make a VERY BRIEF note on each of these