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Chapter 9: Cost Concepts in Economics

Objectives. Explain opportunity cost and its importance in managerial decision makingClarify difference between long and short runDiscuss fixed and variable costsIdentify fixed costs and compute themCompute different average costsExplore economies of size. Opportunity Cost. Opportunity cost is

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Chapter 9: Cost Concepts in Economics

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    1. Chapter 9: Cost Concepts in Economics

    2. Objectives Explain opportunity cost and its importance in managerial decision making Clarify difference between long and short run Discuss fixed and variable costs Identify fixed costs and compute them Compute different average costs Explore economies of size

    3. Opportunity Cost Opportunity cost is based on the fact that every input has an alternative use Opportunity Cost: Value of product not produced because an input was used for another purpose Income that would have been received if the input had been used in its most profitable alternative use

    4. Opportunity Cost Ex: If you produce cotton and make $1000 an acre and produce corn and make $700 an acre, the opportunity cost of producing corn is the $300 Ex: If you make $30,000 a year working for yourself, and could make $40,000 if you were employed by a company, the opportunity cost is the $10,000 Ex: What is the opportunity cost of owning capital (like a tractor)?

    5. Costs Total Fixed Costs (TFC) Total Variable Costs (TVC) Total Costs (TC) Average Fixed Costs (AFC) Average Variable Costs (AVC) Average Total Costs (ATC) Marginal Cost (MC)

    6. Short Run & Long Run Short-run: period of time during which the available quantity of one or more production inputs is fixed and cannot be changed Ex: beginning of the planting season, it may be to late to change the cropland owned or rented Current production cycle is fixed as the available land is fixed Over time land may be purchased, sold, or leases may expire and the amount of land may increase or decrease

    7. Long-run: period of time during which the quantity of all necessary inputs can be changed The actual length will vary depending on the situation and circumstances Short Run & Long Run

    8. Fixed Costs Fixed Costs: costs associated with owning a fixed input or resource DO NOT CHANGE AS OUTPUT CHANGES There are no fixed costs in the long run Total Fixed Costs: (TFC) summation of all fixed costs Does not change with output DIRTI Depreciation (noncash expense) Interest on Investment (either) Repairs (cash expense) Taxes – property (cash) Insurance (either) Interest is also called the opportunity cost of capital and is calculated as: (Cost + Salvage Value)/2 * interest rate Ex: Cost = $20,000, Salvage Value = $5,000 and interest rate is 12%, the interest cost is $1,500.

    9. Fixed Costs What is the total fixed cost if depreciation is $3,000, interest is $1,500, taxes are $25, repairs are $100 and insurance is $50? $4,675 Total fixed costs are usually 20-25% of the purchase price for a depreciable asset

    10. Fixed Costs Average Fixed Costs: TFC / Y AFC will continuously decreases as output increases (spreading fixed costs)

    11. Variable Costs Variable Costs: can be increased or decreased by the manager; will increase as output is increased Ex: feed, fertilizer, seed, fuel Total Variable Costs: (TVC) = Px * x Average Variable Costs: (AVC) = TVC / Y All cost variable costs in the long run

    12. Total and Marginal Costs Total Cost: (TC) sum of TFC and TVC Average Total Cost: (ATC) = AFC + AVC or TC / Y Marginal Cost: (MC) change in TC per one unit change in output = TC / Y

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