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Explicit vs. Implicit Costs

Accounting vs. Economic Profit. Accounting Profit = Revenue - Explicit CostsEconomic Profit = Revenue - Opportunity (Explicit Implicit) CostsEcon Profit accounts for owner's next best alternativee.g.., implicit costs=$15K, explicit costs=$100K, revenues=$300K:Accounting Profit = ??Econ

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Explicit vs. Implicit Costs

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    1. Explicit vs. Implicit Costs Explicit Costs: Actual $ payments made. Implicit Costs: No actual $ payment made Opportunity cost of resource firm owns e.g., owner could earn $15K as teacher, implicitly foregone to run firm. Economic (Opportunity) costs include explicit and implicit costs

    2. Accounting vs. Economic Profit Accounting Profit = Revenue - Explicit Costs Economic Profit = Revenue - Opportunity (Explicit + Implicit) Costs Econ Profit accounts for owner’s next best alternative e.g.., implicit costs=$15K, explicit costs=$100K, revenues=$300K: Accounting Profit = ?? Economic Profit = ??

    3. Zero (normal) economic profit: Just enough to keep owner in business and resources employed there Just equal to its next best alternative. e.g.., owner earned $115K revenues, econ profit = 0 Sunk costs: Irrelevant to decision-making Incurred by past decisions, can’t be undone Examples?

    4. Production and Costs Producing goods requires resources, time, and incurring costs We’ll focus on 3 costs: Total Cost (TC), Average Total Cost (ATC), Marginal Cost (MC) TC = Cost of using inputs to produce given output ATC = (Total Cost) / (Output) MC = D in TC from producing one more unit of output = (D TC) / (D Output)

    5. Numerical examples: Total Cost of 1st unit = 150 Total Cost of 2nd unit = 180 Then for 2nd unit produced: ATC = 180 / 2 = 90 (NOTE: Total Cost = ATC x Output = 2 x 90 = 180) Marginal Cost = TC of 2nd unit (180) - TC of 1st unit (150) = 30

    6. Marginal Physical Product (MPP), Diminishing Marginal Returns, and MC MPP = Extra output from hiring another unit of input (e.g., labor hour): MPP = (D Output) / (D Input) Law of Diminishing Marginal Returns As more input added (to fixed inputs), it’s additional productivity declines Adding another unit increases output by less than previous one. MPP at some point declines

    7. Diminishing Marginal Returns Underlies Concept of Marginal Cost (MC) MC = D in cost associated with D in Output = (D TC) / (D Q) Changing output means hiring extra inputs If MPP increases, MC of producing declines But as diminishing marginal returns sets in, MPP declines

    8. Diminish. marginal returns means MC rises As input’s productivity (MPP) declines, why must (MC) increase? What happens to firm’s MC if diminishing marginal returns never set in?

    9. MPP & MC move in Opposite Directions (using examples in text)

    10. Shape of ATC Curve: Average-Marginal Rule Marginal > average means average rises Marginal < average means average falls “Marginal” pulls “Average” in same direction Example: Average of 3 quizzes = 80, & 4th quiz = 90 Does Marginal Quiz (4th) pull average up/down?

    11. Relation Between Average Total Cost and Marginal Cost ATC decreasing when MC < ATC ATC increasing when MC > ATC At minimum ATC, MC = ATC Minimized per unit cost

    12. Shifts in Cost Curves Taxes per unit produced Input Prices Improved Technology

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