Economics 111.3 Winter 14

1. Economics 111.3 Winter 14 March 7th, 2014 Lecture 20 Ch. 10 (up to p. 231) and Ch. 11

2. Firms Maximize Profit Profit is the difference between total revenue and total cost. Profit = Total revenue – Total cost Profit = Total revenue –Economic cost

3. Profit is the difference between total revenue and total cost.Profit = Total revenue – Total costProfit = Total revenue –Economic cost • ECONOMIC COSTof any resource is the value or worth it would have in its best alternative use • FIRM’S ECONOMIC COST – those payments a firm must make, or incomes it must provide, to resource suppliers to attract the resources away from alternative production opportunities. Economic costs are the sum of Explicit Costs • Money payments a firm must make to non-owners of the firm for the resources they supplied. Implicit Costs • Opportunity costs of firm’s own resources or money payments the self-employed resourcescould have earned in their best alternative use.

4. Implicit Costs: examples The firm’s opportunity cost of using the capital it owns is called the implicit rental rate of capital The implicit rental rate (of capital) is the rental income that the firm forgoes by using its own capital and not renting it to another firm. The firm implicitly rents the capital from itself. The implicit rental rate of capital is made up of 1. Economic depreciation 2. Interest forgone (rental income forgone) Economic depreciation is the change in the market value of capital over a given period. Interest forgone is the return on the funds used to acquire the capital. The same as the opportunity cost to the firm of using its own capital.

5. Implicit Costs: examples, cont’d A firm’s owner often supplies entrepreneurial ability, and also works for the firm. The opportunity cost of the labour supplied is the income that the owner could have earned in the best alternative job. • The return to entrepreneurship is profit. • The profit that an entrepreneur can expect to receive on average is called normal profit. • Normal profit is the cost of entrepreneurship and is a cost of production. • Normal profit is the average return for supplying entrepreneurial ability, and is an opportunity cost to the firm. • Positive Economic Profit is earned when the return to entrepreneurial ability is greater than normal • Negative Economic Profit (Loss) is made when the return to entrepreneurial ability is less than normal

6. Profits to an Economist Profits to an Accountant Economic Profits Accounting Profits Implicit costs (including a normal profit) Total Revenue Economic (opportunity) Costs Accounting costs (explicit costs only) Explicit Costs

13. The Long Run and the Short Run • Long Run – a period of time long enough to enable producers to change the quantity of all resources they employ • In the Long Run • By definition, the firm can vary the inputs as much as it wants. • All inputs are variable.

14. The Long Run and the Short Run • Short Run is a period of time in which producers are able to change the quantities of some but not all the resources they employ • In the short run: • Flexibility is limited. • Some factors of production cannot be changed. • Generally, the production facility (“the plant”) is fixed in the short run

16. Short-Run Production Relationship • Total product (TP or Q) is the number of units of the good or service produced by a different number of workers. • Marginal product is the additional output that will result from an additional worker, other inputs remaining constant.

17. Short-Run Production Relationship Average product (the same as labour productivity) is calculated by dividing total output by the number of workers who produced it.