ECON 1 Lecture Notes - Lecture 11: Variable Cost, Fixed Cost, Average Cost

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greyrabbit304

29 May 2018

School

Santa Clara University

Department

Economics

Course

ECON 1

Professor

Cameron- Loyd

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ECON 1: Chapter 13 Notes

Focus Questions:

• What is a production function? What is marginal product? How are they related?

• What are the various costs, and how are they related to each other and to output?

• How are costs different in the short run vs.

the long run?

• What are “economies of scale”?

Total Revenue, Total Cost, Profit

▪ We assume that the firm’s goal is to maximize profit.

Costs: Explicit vs. Implicit

▪ Explicit costs require an outlay of money,

▪ e.g., paying wages to workers.

▪ Implicit costs do not require a cash outlay,

e.g., the opportunity cost of the owner’s time.

▪ Remember one of the Ten Principles:

The cost of something is what you give up to get it.

▪ This is true whether the costs are implicit or explicit. Both matter for firms’ decisions.

Economic Profit vs. Accounting Profit

▪ Accounting profit = total revenue minus total explicit costs

▪ Economic profit = total revenue minus total costs (including explicit and implicit costs)

▪ Accounting profit ignores implicit costs, so it’s higher than economic profit.

The Production Function

▪ A production function shows the relationship between the quantity of inputs used to produce a good

and the quantity of output of that good.

▪ It can be represented by a table, equation, or graph.

▪ Example 1:

o Farmer Jack grows wheat.

o He has 5 acres of land.

o He can hire as many workers as he wants.

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Marginal Product

▪ If Jack hires one more worker, his output rises by the marginal product of labor.

▪ The marginal product of any input is the increase in output arising from an additional unit of that input,

holding all other inputs constant.

▪ Notation:

∆ (delta) = “change in…”

Examples:

∆Q = change in output, ∆L = change in labor

▪ Marginal product of labor (MPL) = ∆Q/∆L

Why MPL Is Important

▪ Recall one of the Ten Principles:

Rational people think at the margin.

▪ When Farmer Jack hires an extra worker,

▪ his costs rise by the wage he pays the worker

▪ his output rises by MPL

▪ Comparing them helps Jack decide whether he should hire the worker.

Why MPL Diminishes

▪ Farmer Jack’s output rises by a smaller and smaller amount for each additional worker. Why?

▪ As Jack adds workers, the average worker has less land to work with and will be less productive.

▪ In general, MPL diminishes as L rises

whether the fixed input is land or capital (equipment, machines, etc.).

▪ Diminishing marginal product: the marginal product of an input declines as the quantity of the input

increases (other things equal)

Marginal Cost

▪ Marginal Cost (MC) is the increase in Total Cost from producing one more unit:

Why MC Is Important

▪ Farmer Jack is rational and wants to maximize his profit. To increase profit, should he produce more or

less wheat?

▪ To find the answer, Farmer Jack needs to “think at the margin.”

▪ If the cost of additional wheat (MC) is less than the revenue he would get from selling it, then Jack’s

profits rise if he produces more.

Fixed and Variable Costs

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Related Questions

Accounting profit is equal to total revenue minus the explicit cost of producing goods and services while economic profit is the difference of total revenue minus the sum of both explicit and implicit costs. Therefore, the economic profit

1. is always at least as large as accounting profit if the implicit cost is greater than zero.

2. is always less than accounting profit if the implicit cost is greater than zero.

3. will always exceed accounting profit.

4. will always equal to accounting profit.

orchidrabbit535

26. To the economist total cost includes

A. explicit and implicit costs.

B neither implicit nor explicit costs.

C. implicit, but not explicit, costs.

D. explicit, but not implicit, costs.

27. Accounting profits are typically

A. greater than economic profits because the former do not take explicit costs into account

B. equal to economic profits because accounting costs include all opportunity costs.

C. smaller than economic profits because the former do not take implicit costs into account.

D. greater than economic profits because the former do not take implicit costs into account.

28. Suppose that a business incurred implicit costs of $200,000 and explicit costs of $1 million in a specific year. If the firm sold 4,000 units of its output at $300 per unit, its accounting profits were

A. $100,000 and its economic profits were $0.

B. $200,000 and its economic profits were $0.

C. $100,000 and its economic profits were $100,000.

D. $0 and its economic loss was $200,000.

29. The basic difference between the short run and the long run is that

A. all costs are fixed in the short run, but all costs are variable in the long run.

B. the law of diminishing returns applies in the long run but not in the short run.

C. at least one resource is fixed in the short run, while all resources are variable in the long run.

D. economies of scale may be present in the short run but not in the long run.

30. The law of diminishing returns indicates that

A. as extra units of a variable resource are added to a fixed resource, marginal product will decline beyond some point.

B. because of economies and diseconomies of scale, a competitive firm's long-run average total cost curve will be U-shaped.

C. the demand for goods produced by purely competitive industries is downsloping.

D. beyond some point, the extra utility derived from additional units of a product will yield the consumer smaller and smaller extra amounts of satisfaction.