23.1 Economic Cost and Economic Profit

• A firm’s explicit cost is its actual monetary payments for inputs.

• A firm’s implicit cost is the opportunity cost of the inputs that do not require monetary payment.

• Two examples of inputs whose costs are implicit rather than explicit:

  • Opportunity cost of the entrepreneur’s time- If an entrepreneur could earn $5,000 per month in another job, the opportunity cost of the time spent running the firm is $5,000 per month.

  • Opportunity cost of the entrepreneur's funds- Many entrepreneurs use their own funds to set up and run their businesses. If an entrepreneur starts a business with $200,000 withdrawn from a savings account, the opportunity cost is the interest income the funds could have earned in the bank, for example, $2,000 per month.

Economic cost = explicit cost + implicit cost

• Accounting cost is the explicit cost of production.

• Accounting profit is the total revenue minus accounting cost.

23.2 A Firm with a Fixed Production Facility: Short-Run Costs

• Marginal product of labor is the change in output from one additional unit of labor.

• Diminishing returns is as one input increases while the other inputs are held fixed, output increases at a decreasing rate.

  • The principle of diminishing returns is suppose output is produced with two or more inputs and we increase one input while holding the other inputs fixed. Beyond some point-called the point of diminishing returns output will increase at a decreasing rate.

• The total-product curve is a curve showing the relationship between the quantity of labor and the quantity of output produced.

• The fixed cost (FC) is the cost that does vary with the quantity produced.

• The variable cost (VC) is the cost that varies with the quantity produced.

• The average fixed cost (AFC) is the fixed cost divided by the quantity produced.

• The average variable cost (AVC) is the variable cost divided by the quantity produced.

• The short-run average total cost (ATC) is the short-run total cost divided by the quantity produced, equal to AFC plus AVC.

• The two forces that both push ATC downward as output increases, so the curve is negatively sloped for small quantities of output are:

  • Spreading the fixed cost is for small quantities of output, a one-unit increase in output reduces AFC by a large amount because the fixed cost is pretty “thick”, being spread over just a few units of output.

  • Labor specialization is for small quantities of output, AVC decreases as output increases because labor specialization increases worker productivity.

• A short-run marginal cost (MC) is the change in short-run total cost resulting from a one-unit increase in output.

23.3 Production and Cost in the Long Run

• A long-run total cost (LTC) is the total cost of production when a firm is perfectly flexible in choosing its inputs.

• A long-run average is a long-run cost divided by the quantity produced.

• The constant returns to scale is a situation in which the long-run total cost increases proportionately with output, so the average cost is constant.

• The long-run marginal cost (LMC) is the change in long-run cost resulting from a one-unit increase in output.

• The invisible input is an input that cannot be scaled down to produce a smaller quantity.

• The economics of scale is a situation in which the long-run average cost of production decreases as output increases.

• The minimum efficient scale is the output at which scale economics are exhausted.

• A diseconomies of scale is a situation in which the long-run average cost of production increases as output increases.

23.4 Examples of Production Cost

• The Average Cost of a Music Video

  • The average cost of a music video depends on how many copies are distributed and suppose the music video can be distributed online, at zero marginal cost.

  • The average cost is $233 if 1,000 copies are distributed online, and drops to $0.23 if one million copies are distributed.

  • The gap decreases as the fixed production cost is spread over a larger number of copies.