Cost of Production

P R O D U C E R B E H AV I O R A N D S O C I E T Y

Outline
Explicit and Implicit Cost

Accounting, Economic and Normal Profit

Fixed Cost and Variable Cost Total and Marginal Cost

What is Production?
Production- the process of transforming resources or

factors of production into goods and services to satisfy human needs and wants.

Land

Labor

Entrepreneurship

Capital

Production function

Q=f (h, l, k, ent)

Q= quantity of product produced

h= quantity of land employed

L= quantity of labor employed K= quantity of capital employed

Ent= quantity of ent employed

COST
Main objective of the firm: reduce cost and

maximize profit.

 Cost (in common usage)- is the monetary value of

goods and services that producers and consumers purchased.

Cost (in economic sense)-is the measure of the

alternative opportunities forgone in the choice of one good or activity over others.

Source:http://www.britannica.com

Explicit and Implicit costs

A firm's explicit costs are the monetary payments

(or cash expenditures) of a firm must make to an outsider to obtain resource.

Examples: wages paid to workers Payments to suppliers of raw materials.

 A firm's implicit costs are the opportunity costs of

using its self-owned, self-employed resources.

Example:
the interest that could be earned were the owners

assets not tied up in the business value of an entrepreneurs labor

 Total Economic cost is the sum of explicit cost and

implicit cost.

Accounting and Economic Profit

Accounting profits are the firm's total revenues

from sales of its output, minus the firm's explicit costs.

 Economic profits are total revenues minus explicit

and implicit costs.

Occurs when total revenue > total cost.

 A firm is said to make normal profits when its

economic profits are zero.

Sample Exercise 1
Imagine that two years after receiving your college

degree your annual salary as an assistant store manager is $28,000, you own a building that rents for $10,000 yearly, and your financial assets generate $3,000 per year in interest. On New Years Day, after deciding to be your own boss, you quit your job, evict your tenants, and use your financial assets to establish a pogo-stick shop. At the end of the year, your books tell the following story:

 Total Sales

Revenue $130,000 Cost of pogo sticks $85,000 Employees wages 20,000 Utilities 5,000 Taxes 5,000 Advertising expenses 10,000 Total (Explicit) Costs 125,000 (subtract from revenue) Accounting Profit 5,000

 Hold it just a moment, you say, I have

studied economics. You forgot to subtract my implicit costs. Being in this business caused me to lose as income

 Salary

Rent
Interest Total Implicit

28,000 10,000 3,000

Costs

41,000

Therefore, Ive had an economic profit thats

negative, a loss of

36,000

Sample Exercise 2
Suppose that your current total revenue in farming is

120,000 per year and that your costs are 10,000 per year for seed and fertilizer, 12,000 for other supplies, and 15,000 interest on machinery loans. You have been offered another job that would pay 50,000 per year. If you took it, you could sell your farm and machinery and earn 70,000 per year interest on the money you had invested in land and machines. Should you take your job? Explain your answer in terms of economic cost.

Fixed,Variable and Total Cost

Fixed costs are the costs that in total do not vary

with changes in output.

Example: rental payments, insurance premiums

 Variable Costs are those costs that change with the

level of output.

 Total cost is the sum of variable cost and fixed cost.