Firms must know their cost of production in order to produce the profitprofit-maximizing quantity of output.

To maximize profits, each firm must select its quantity of output. That decision involves considering both cost and revenues.

Economic Cost
In Economics , costs include Explicit and Implicit costs Explicit Cost - Out of Pocket cost Implicit cost inputs owned ny the firm, opportunity cost has to be estimated

Normal Profit, Economic Profit, and Accounting Profit

 All of the cost accountants measure are called explicit cost.
 Explicit cost are are all internal to the firm in that they depend upon decisions that the firm makes.

 Accountants do not measure implicit cost (opportunity cost).

 Implicit cost are associated with non-purchased inputs.  These are the cost that the firms capital and entrepreneurs time would have had in their best alternative uses.

Normal Profit, Economic Profit, and Accounting Profit

o Accounting profit = Total revenue- Explicit cost o Economic profit = Accounting profit - Implicit cost o Economic profit = Accounting profit Normal profit o A normal profit is a cost. It is the accounting profit needed to keep the firm in business.

Normal Profit, Economic Profit, and Accounting Profit

Accounting Profit
Total Revenue

Economic Profit Normal profit

Total Revenue

Explicit Cost

Explicit Cost

Normal Profit, Economic Profit, and Accounting Profit

TOTAL REVENUE $50,000
Minus explicit costs: Raw food and supplies - $27,000 Hired labor - $13,000

Minus implicit costs: Value of Alis entrepreneurship in alternative business venture Value of Alis labor at a different job Value of alternative investments that Ali could have made

Accounting profit $10,000

- $3,000 - $2,000 - $1,000

Economic profit $ 4,000

Normal Profit, Economic Profit, and Accounting Profit

Because implicit cost are subtracted from accounting profit to obtain economic profit, economic profit will always be less than accounting profit. Excess profits are earned when total revenue is greater than total cost. Negative profits are incurred when total revenue is less than total cost. A firm is earning zero economic profits (breakeven) when total revenue equals total cost.

Accounting Profit and Economic

Accounting Profit = Total Revenue Explicit cost (Accounting Cost ) Economic Profit = Total Revenue Economic Costs ( Explicit and Implicit Costs )

Hema opens up her own economic consulting practice. The fee she charges per hour is Rs.100. In order to start her own business Hema quit her job which was paying Rs.50,000 per year and cashed in a Rs.10,000 certificate of deposit that was yielding 5% interest per year. During the first year, expenses for items such as paper and utilities totaled Rs.5,000. If Helen provides 1,000 hours of consulting services in her first year , then her economic profit equals: a. Rs.44, 500 b. Rs.35,000 c. Rs.85, 000 d. Rs.94, 500

 A lawyer working for a large law firm and earning Rs.6, 00,000 per year, is contemplating setting up his own law practice. He estimates renting an office would cost Rs. 100,000 per year, hiring a legal secretary would cost Rs. 200,000 per year, renting the required office equipments would cost Rs. 1,50,000 per year, and purchasing the required supplies, paying for the electricity, telephone, and so forth would cost another Rs. 50,000.The lawyer estimates that his total revenues for the year would be Rs. 10,00, 000, and he is indifferent between keeping his present occupation with the large law firm and opening his own law office. a) How much is the explicit costs of the lawyer for running his own law office for the year? b) How much would the accounting cost be? The implicit cost? The economic cost? c) Should the lawyer go ahead and start his own business?

ShortShort-Run Costs
Fixed costs are those costs associated with fixed inputs. Fixed costs remain constant as output changes. Variable costs increase as output rises and decline as output falls. Variable costs are associated with the firms variable inputs. Total Cost = Total Fixed Cost + Total Variable Cost

ShortShort-Run Costs
Total cost, like variable cost, will vary directly with output in the short run. Sunk cost are cost that cannot be recovered. Sunk cost are irrelevant to decision making. We can do nothing about the sunk cost, so we ignore these cost when making decisions.

Total cost = Total Variable + Total Fixed cost

Quantit Toral y of Fixed output Cost 0 1 2 3 4 5 60 60 60 60 60 60 Total Variabl e cost 0 20 30 45 80 135 Total Costs Averag e Fixed Cost 60 30 20 15 12 Averag e Variabl e cost 20 15 15 20 27 Averag e Total Cost 80 45 35 35 39 Margin al cost

60 80 90 105 140 195

20 10 15 35 55

Relating Total Product to Total Cost

o A firms total cost of output will equal the labor requirement for that output multiplied by the wage rate.
o Total variable cost = Wage rate x Labor

o With capital as the only fixed input we have.

Total fixed cost = Per unit cost of capital x Amount of capital employed

The Total Product of Labor

Total Product

Increasing Marginal Product

Decreasing Marginal Product

Increasing Marginal Product

Labor

Total Cost, Total Fixed Cost, and Total Variable Cost Curves
Total Cost Total Variable Cost

Total Fixed Cost

Decreasing marginal cost Increasing marginal cost

Quantity

Marginal Cost
Marginal cost is the additional cost of an additional unit of output. Marginal Cost = ( total cost/ ( quantity or = ( total variable cost/ ( quantity

Marginal Cost = Slope of total cost or = Slope of total variable cost

Average Cost
Average cost = Total cost Quantity of output Average cost is also called average total cost because it is the total of both the fixed and variable components of average costs: Average cost = Average fixed cost + Average variable Average fixed cost Average cost = cost Average variable cost where Average fixed cost = Total fixed cost Quantity of output and Average variable cost = Total variable cost Quantity of output

Marginal Cost, Average Cost, and Average Variable Cost Curves

Marginal Cost Average Cost Average Variable Cost

Quantity

Computing Marginal and Average Cost

Marginal Cost = Wage rate Marginal product Total variable cost Quantity of output Wage rate x Labor Quantity of output Wage rate Average product of output

Average Cost =

Average variable cost =

Average variable cost =

Long Run Cost is also called Envelop curve . Generally LAC is U shaped It may be L shaped , declining or HORIZONTAL too.
Learning Curve : Average cost declines as production increases ,but at a decreasing rate .

An Andaman Cruise operator would like to analyze the cost of operating the Cruise at various capacity levels. He can hire the ship for Rs.10,000/- per week. It is the only fixed cost to him. The total variable cost (TVC) of taking abroad another passenger, i.e. TVC = Q3 + 10,000 Q0.5. a. What is the Total Cost (TC)? b. What is the Average Fixed Cost (AFC)? c. What is the Average Total Cost (ATC)? d. What is the Marginal Cost (MC)?