Markets

By
Azhar Mehmood
Costs of Production
Economic Cost
The payment that must be made to obtain and retain the services of a
resource. It is the income the firm must provide to resource suppliers to
attract resources away from alternative uses.
Explicit Costs
A firm’s explicit costs are the monetary payments it makes to those from
whom it must purchase resources that it does not own. Because these
costs involve an obvious cash transaction, they are referred to as explicit
costs.
Implicit Costs
A firm’s implicit costs are the opportunity costs of using the resources
that it already owns to make the firm’s own product rather than selling
those resources to outsiders for cash. Because these costs are present but
not obvious, they are referred to as implicit costs.
Costs of Production
Accounting Profit and Normal Profit
Accounting profit is the result of subtracting only explicit costs from
revenue:
Accounting Profit = Revenue-Explicit Costs
Economic profit is the result of subtracting all of your economic costs—

both explicit costs and implicit costs— from revenue:
Economic Profit = Revenue - Explicit Costs - Implicit Costs.

Costs of Production
Short Run
the short run is a period too brief for a firm to alter its plant capacity, yet
long enough to permit a change in the degree to which the plant’s current
capacity is used. The firm’s plant capacity is fixed in the short run.
However, the firm can vary its output by applying larger or smaller
amounts of labor, materials, and other resources to that plant. It can use
its existing plant capacity more or less intensively in the short run.
Long Run
the long run is a period long enough for a firm to adjust the quantities of
all the resources that it employs, including plant capacity. From the
industry’s viewpoint, the long run also includes enough time for existing
firms to dissolve and leave the industry or for new firms to be created
and enter the industry. While the short run is a “fixed-plant” period, the
long run is a “variable-plant” period.
Costs of Production
Total product (TP)
is the total quantity, or total output, of a particular good or service
produced.
Marginal product (MP)
is the extra output or added product associated with adding a unit of a
variable resource.
Marginal product= change in total product/change in labor input •
Average product (AP), also called labor productivity,
is output per unit of labor input:
Average product = Total product / units of labor
In the short run, a firm can for a time increase its output by adding units
of labor to its fixed plant.
Costs of Production
Costs of Production
Costs of Production
Fixed Costs
Fixed costs are those costs that do not vary with changes in output. Fixed costs
are associated with the very existence of a firm’s plant and therefore must be
paid even if its output is zero. Such costs as rental payments, interest on a
firm’s debts, a portion of depreciation on equipment and buildings, and
insurance premiums are generally fixed costs; they are fixed and do not change.
Variable Costs
Variable costs are those costs that change with the level of output. They include
payments for materials, fuel, power, transportation services, most labor, and
similar variable resources. Note that the increases in variable cost associated
with succeeding one-unit increases in output are not equal. As production
begins, variable cost will for a time increase by a decreasing amount.
Total Cost
Total cost is the sum of fixed cost and variable cost at each level of output:
TC = TFC + TVC
Costs of Production
Average fixed cost (AFC)
for any output level is found by dividing total fixed cost (TFC) by that
amount of output (Q).
AFC=TFC/Q
Because the total fixed cost is, by definition, the same regardless of
output, AFC must decline as output increases. As output rises, the total
fixed cost is spread over a larger and larger output.
Average variable cost (AVC)
for any output level is calculated by dividing total variable cost (TVC)
by that amount of output (Q):
AVC=TVC/Q
Due to increasing and then diminishing returns, AVC declines initially,
reaches a minimum, and then increases again. A graph of AVC is a U-
shaped or saucer-shaped curve.
Costs of Production
Average total cost (ATC)
for any output level is found by dividing total cost (TC) by that output
(Q) or by adding AFC and AVC at that output:
ATC= TC/Q = TFC/Q + TVC/Q = AFC+TVC
Graphically, ATC can be found by adding vertically the AFC and AVC
curves . Thus the vertical distance between the ATC and AVC curves
measures AFC at any level of output.
Marginal Cost
is the extra, or additional, cost of producing one more unit of output. MC
can be determined for each added unit of output by noting the change in
total cost entailed by that unit’s production:
MC = change in TC / change in Q
Costs of Production
Costs of Production
Costs of Production
Costs of Production
Costs of Production

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Economic profit is the result of subtracting all of your economic costs—

Economic Profit = Revenue - Explicit Costs - Implicit Costs.

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