Costs of production

Opportunity cost of production = what you sacrifice to produce something. Opportunity costs are either explicit or implicit Explicit costs are opportunity costs of imputs the firm purchases from others. Actual monetary payments measure the cost. Implicit costs are the opportunity costs of using a firm's own imputs (no purchase required) as measured by the value of the alternative foregone. Opportunity cost of entrepreneur's time = foregone wage or salary income Opportunity cost of funds = lost interest could have earned

Example

Which are explicit and which are implicit? To get started, a business owner used $7,500 of his own funds to buy supplied. These funds could have earned 10% if invested in a financial asset of equal risk. Yearly rental on the store = $4800 Cost of goods from wholesaler = $50,000 Wages paid to employees = $18,000 Onwer quits his previous job paying $21,000 per year to operate his own store. Electricity, advertising, etc. = $1,200 Explicit costs = 4,800 + 50,000 + 18,000 + 1,200 = $74,000 Implicit costs = $750 + 21,000 = 21,750 Total costs = $95,750

Costs in the Short Run
Fixed inputs (capital, entrepreneurship) give rise ot fixed costs = costs which remain the same regardless of the level of output. Variable inputs (labor, materials) give rise of variable costs = costs which change as the level of output changes. Total costs = Fixed costs + variable costs.

Labor	Materials	Output	MP
0	0	0	-
1	6	1	1
2	12	2	1
3	15	2.5	0.5
4	18	3	0.5
5	20	3.33	0.33
6	22	3.67	0.33
7	24	4	0.33

Output	Labor Costs (wxL)	Material Costs (pxM)	TVC Labor + materials	TFC	TC	MC
0	0x$50 = 0	0x$5=0	0+0=0	$75	75	--
1	1x50=50	6x5=30	50+30=80	75	155	80
2	2x50=100	12x5=60	100+60=160	75	235	80
3	4x50=200	18x5=90	200+90=290	75	365	130
4	7x50=350	24x5=120	350+120=470	75	545	180

Rising Marginal Costs

Marginal cost is the additional cost associated with producing an extra uit of the product. MC= change in total costs / change in output. Because each additional workers adds less to output (diminishing returns), it will require progressively greater increases inthe workforce to get output to increase by one. Consequently, the extra labor costs and hence marginal costs of an extra unit of output rise as production increases. The marginal cost curve is (eventually upward-sloping).

Short Run Costs
Specialization may lead to MC which declines as output increases; eventually, diminishing returns will cause the MC curve to be upward-sloping. Rising marginal cost leads to accelerating variable costs and total costs-- the variable costs and total cost curve become steeper as output increases. Fixed costs do not change whatever output is produced in the short run.

Average total cost is total cost divided by output or cost per unit. When MC < ATC, ATC declines; when MC > ATC, ATC is rising; when ATC is at a minimum when MC = ATC. Rising marginal cost leads to increasing cost per unit and average variable cost per unit as output increases. Average or per unit fixed costs decline ("spreading the overhead")

Some Identities
TC = FC + TVC SATC = TC / Q; SAVC = TVC /Q; AFC = FC/Q ATC = AVC + AFC MC = change in TC/ change in Q = change in TVC /change in Q

Production in the Long Run
All inputs are variable in the long run so all costs are variable costs in the long run. There are no long run fixed costs. The law of diminishing returns does not apply in the long run as no inputs are fixed

Economies of Scale
Doubling all inputs yields more than double the output. Doubling the output requires less than double the inputs. Cost per unit (LAC) falls as output rises. Reasons for: Indivisible inputs (lumpiness) Specialization Multiplicative relation of inputs Use of by products Financial economies--volume discounts

Long Run Costs
Eventually economies of scale end. Then, doubling all inputs yields double the output (constant returns to scale). Cost per unit is constant as output increases. Further increases in output take more than proportionate increases in some inputs. Cost per unit rise as output increases. Problems of coordinating large organizations require proprotionately more management resources.

Marginal Revenue

Total revenue is what the firms gets from selling its product. Total revenue is the firm's receipts or dollar sales. Total revenue is NOT the same as profit. The marginal benefit to a firm from producing an additional unit is the extra revenue the firm gets from the sale of that unit. Marginal revenue is the change in the firm's total revenue as a result of selling an additional unit. MR = change in (pQ) / change in Q where Q is output. How marginal revenue changes as output changes depends on the type of market the firm sells in.

Perfect Competition
Characteristics of the industry A very large number of firms selling and a very large number of buyers Identical products -- buyers can't distinguish among the products of different firms. Easy entry and exit -- no legal or significant economic barriers to new firms beginning production. Example: corn, wheat

Revenues under Perfect Competition
Perfectly competitive firms are price takers. Each firm is too small for its action to change the market price. A firm can sell all it wants without changing the market price and none at any higher price. The marginal revenue (marginal benefit) the firm gets from an additional unit equals the market price.