*Cost of Production

*Economic Cost cost of utilizing economic resources in production, including opportunity cost.

Opportunity Cost- cost associated with opportunities

that are forgone when a firm’s resources are not put to their best alternative use.

*Explicit and Implicit CostsExplicit Cost

- a cost that involves spending money

- requires an outlay of money

Example: paying wages to workers

Implicit Cost a non-monetary opportunity cost, including

normal profit to the entrepreneur

do not require a cash outlay

*Example:

the opportunity cost

of the owner’s time

*Illustration:

•Suppose you are earning $22,000 a year as a sales representative for a T-shirt manufacturer.

•And you invest $20,000 of savings that have been earning you $1000 per year.

•But, at some point you decide to open a retail store of your own to sell T-shirts.

•And you decide that your new firm will occupy a small store that you own and have been renting out for $5,000 per year.

•You hire one clerk to help you in the store, paying her $18,000 annually.

•Additional Information: Cost of T-Shirts --------------------------- $40,000

Utilities Expenses ------------------------ $ 5,000

oYour entrepreneurial talent is worth $5,000 annually in other business endeavors of similar scope.

A year after you open the store, you total up your accounts and find the following:

Total sales revenue ------------ $120,000 Cost of T-shirts ---------- $40,000

Clerk’s salary ------------- 18,000

Utilities -------------------- 5,000

Total (explicit) costs --------------- 63,000Accounting profit ----------------------- 57,000

Accounting profit ----------------------- $57,000 Forgone interest ------------ $1,000

Forgone rent --------------- 5,000

Forgone wages -------------- 22,000

Forgone entrepreneurial income ---- 5,000

Total implicit costs --------------------------- 33,000 Economic profit -------------------------------- 24,000

Considering the implicit costs:

*Accounting Profit vs. Economic ProfitAccounting profit

- total revenue minus total explicit costs

Economic profit- total revenue minus economic costs or

the total costs (including explicit and implicit costs)

“Accounting profit ignores implicit costs, so it’s higher than economic profit.”

Profits to anEconomist

Profits to anAccountant

Economic Profit

Implicit cost ( including a normal profit)

Explicit cost

Accounting Profit

Accounting costs ( explicit costs only)To

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*Short Run and Long RunShort Run

a period of time where one factor of production is fixed (capital stock such as plant) and all others are variable such as labor, materials, and other resources to that.

has a fixed plant capacity size.

Long Run a time period where all factors of production, even the capital stock such as plant, are variable

has a variable plant capacity size.

*Illustration:

• If a firm hires 100 extra workers for one of its commercial airline plants or adds an entire shift of workers.

• But, if it adds a new production facility and install more equipment.

- Short-Run

- Long-Run