Department
01' Economics,
Management
and Humanities
Czech Technical University in Prague
ECONOMICS SLlDiS
;;
LECTURE N 0.5
COSTS OF PRODUCTION Handout
Doc. Ing. Helena Fialová, CSc. Ing. .Tan.Tandera
Prague
2000/200 I
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Lecture 5 THE COSTS OF PRODUCTION ECONOMIC COSTS Explicit costs + implicit costs
Explicit costs -> money payments to suppliers of resources Explicit costs
= accounting
costs
Implicit costs -> opportunity costs of self-owned, self-employed resources (i.e. no money payments) Implicit costs include normal profit, which is an average profit in the industry (a payment one can receive for performing entrepreneurial functions)
ECONOMIC PROFIT Economic profit is called pureprofit. Calculating profit
Accounting profit Economic profit
= total revenue - accounting
costs
= total revenue - (explicit costs + implicit costs including a normal profit)
SHORT RUN and LONG RUN Short run
- a firm's
capacity is fixed
Long run - a firm can vary its plant size
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EXAMPLE (a sales representative for a CDs manufacturer): Total
sales revenue
.............
Price ofCDs Clerk's Utilities Total
(explicit)
USD 120,000
USD
40,000 20,000 5,000
.... . ........
salary
. . . . .. . . . . . .. .
costs
65,000 55,000
Accounting profit. . . . . . . . . . . . . . . . .
Forgone interest Forgone rent
.. .. USD
1,000
. ... .. .. .
5,000
Forgone wages . ... .. ..
20,000
Forgoneentrepreneurialincome5,000 Total implicit costs ECONOMIC
. ... .. ... .. .. .. .
PROFIT.
............
31,000
24,000
SHORT RUN PRODUCTION RELATIONSHIPS LA W OF DIMINISHING MARGINAL RETURNS Beyond some point, output will increase by diminishing amounts as more units of a variable resource (labor) are added to a fixed resource (capital). Total product - marginal product - average product MARGINAL PRODUCT = change in total product associated with additional input of labor AVERAGE PRODUCT
= output
per worker (labor productivity)
Example (Fig. 5.1)
Note: wherever MP exceeds AP, AP will rise. Wherever MP is less than AP, AP must be declining. MP intersects AP where AP is at a maximum.
2
FlXED, VARIABLE and TOT AL COSTS ln the short run costs are either flXedor variable. Fixed costs (FC) - costs which in total do not vary with changes in output Variable costs (VC)
- costs which
change with the level of output
Total costs (TC) =fIXed costs + variable costs
TC=FC+ VC
(Fig. 5.2, 5.3)
AVERAGE COSTS (costs per unit) (Fig~5.4)
TFC AFC = ----Q TC ATC = ---Q
TVC A VC = ------
Q
ATC=AFC+AVC
AFC decIines with the increase of output. AVC and ATC are U-shaped. MARGINAL COSTS (costs ofproducing one more unit of output) (Fig. 5.5) change in TC Me = ---------------change in Q MC faD and then rise. MC curve intersects the ATC and AVC curves at their minimum points. (Fig. 5.6, 5.7) Example (Fig. 5.8)
LONG RUN PRODUCTION COSTS Economies of scale Decreasing per unit costs as consequence of specializationof labor and management, efficient capital equipment etc. Diseconomies of scale Rising per unit costs in large firms. Constant returns to scale Long run average costs are constant. 3
p
n ---
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Fig. 5.1 Total. Man?:inal and Avera1!e Product: The Law ofDiminishin1! Mar1!inal Returns
...
""",:"::'-'
Ihe v6ri~bié'-"'" resource Ilobor)
próduc! (TP) nn_PnU'
o 1 2 3 4 5 6 7 8
giribl"
product chonge chonge
--- -'--"--'
'''---''
!MP\, in (2)/
',
o 1.L
lJ1
cr
Fig. 5.6 Relationship
between Total, Áverage and Marginal Costs
Tvt ~.
A
o
ry
~ MC AVG
o
111
48
r
Fig. 5.7 Relationship
between Avera2e and Mar2inal Costs
~ MC
ATC Avt
r
o
J
~
AFG o
~tr
Fig. 5.8
Tota)- Avera2:e- and Mar2:ina)-Cost Schedu)es for an Individua) Firm in the Short Run
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,
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Total-costdata
(11 Total product (Qj
(21 Total fixed cost
(31 Total variable cost
(TFCj
(NCj
$100 100 100 100 100 100 100 100 100 100 100
$ O 90 170 240 300 370 450 540 650 780 930
Marginal cost
Total cost (Tq
Average fixed cost (AFq
Average variable cost (AVCj
(7) Average total cest (ATCj
TC= TFC
TFC AFC='Q
NC AVC= Q
TC ATC=Q
$100.00 50.00 33.33 25.00 20.00 16.67 14.29 12.50 11. 11 10.00
$90.00 85.00 80.00 75.00 74.00 75.00 77.14 81.25 86.67 93.00
$190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00
(41
. (51
+ NC
O 1 2 3 4 5 6 7 8 9 10
','
Average-
