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By: Christopher Mazzei
Viewpoints
• The owner of a company wants to keep costs
down.
• An employee of the company wants a high
wage or salary.
• There is always a permanent balancing act
between employer and employee(s).
Profit
• The firm is concerned with keeping costs down so
that its generated revenue is greater than its total
costs.
• Profit = Total Revenue – Total Cost
• Explicit costs are costs that require the outlay of
money. For instance, the explicit cost of a year of
college is the tuition.
• Implicit costs are instead the value of the benefits
that are given up. For instance, the implicit cost
of a year in college is the income that you would
have earned if you had gotten a job instead.
Accounting Vs. Economic Profit
• Accounting Profit = the business’s total revenue
minus the explicit cost and depreciation value.
• Economic Profit = the business’s total revenue
minus the opportunity cost of its resources (Total
Revenue minus (Explicit costs + Implicit costs).
• Normal Profit – when a firm’s economic profit
equals zero (the firm is making just enough profit
to stay in business and to continue producing at
the same level)
Types of Costs
• Total Fixed Costs - costs that do not vary with output TFC
• Total Variable Costs - costs that vary with the rate of
production TVC
• Average Fixed Costs = total fixed costs divided by the # of
units produced AFC
• Average Variable Costs = total of variable costs divided by
the # of units produced AVC
• Average Total Costs = total costs divided by the # of units
produced ATC
• Marginal Costs = change in total costs due to a change in
production of one unit MC = change in TC /change in Q
• Total Costs = Fixed Costs + Variable Costs TC
Fixed Costs
• Costs that remain constant whether you produce
0 units or millions of units of a product.
• The rent on the land your business resides is
considered a fixed cost, the loan payment if you
build a factory is a fixed cost, salary workers are
fixed costs, and your business license is a fixed
cost. These payments will remain constant no
matter how many units are produced.
• In the short run, fixed costs cannot be altered. In
the long run however, all costs are variable.
Variable Costs
• Costs that change whether you produce 1 unit
or millions of units of a product.
• Variable costs change as you increase
production, starting with the first unit.
• The cost of raw materials to produce/sell your
product, your firms electricity usage, your
phone bill and your office supplies expenses
are all variable costs that increase as your
company’s output increases.
Total Cost Graph
Average Cost Graph
Returns to Scale
• Economies of Scale – when a firm’s long-run average
total cost declines as it’s output increases.
• Increasing Returns to Scale – when output increases
more than in proportion to an increase in all inputs
• Diseconomies of Scale - when a firm’s long-run average
total cost increases as it’s output increases.
• Decreasing Returns to Scale – when output increases
less than in proportion to an increase in all inputs.
• Constant Returns to Scale – when output increases
directly in proportion to an increase in all inputs
Sunk Costs
• Sunk Cost – a cost
that has already
been incurred and
cannot be
recovered.
• Sunk costs should be
ignored in a decision
about future actions
because they have
no influence on
future costs and
benefits.
MR = MC
• The point at which Marginal Revenue equals the Marginal
cost. When displayed on a graph it shows the Profitmaximizing quantity of output at the market price.
Exam Questions
1. As its output increases, a firm’s short-run marginal cost will eventually increase because of
(a) diseconomies of scale
(b) a lower product price
(c) inefficient production
(d) the firm’s need to break even
(e) diminishing returns
7.For a firm hiring labor in a perfectly competitive labor market, the marginal revenue product curve slopes
downward after some point because as more of a factor is employed, which of the following declines?
(a) Marginal product
(b) Marginal factor cost
(c) Marginal cost
(d) Total output
(e) Wage rates
8.Which of the following is always true of the relationship between average and marginal costs?
(a) Average total costs are increasing when marginal costs are increasing.
(b) Marginal costs are increasing when average variable costs are higher than marginal costs.
(c) Average variable costs are increasing when marginal costs are increasing.
(d) Average variable costs are increasing when marginal costs are higher than average variable costs.
(e) Average total costs are constant when marginal costs are constant.
Exam Questions Cont.
Links to Real World Costs!
• http://www.networkworld.com/news/2009/0
12609-companies-cutting-costs.html
• https://power2switch.com/static/cases/mcdo
nalds.pdf