Economics 111.3 Winter 14
March 7th, 2014
Lecture 20
Ch. 10 (up to p. 231)
and Ch. 11
Firms Maximize Profit
• Profit is the difference between total
revenue and total cost.
Profit = Total revenue – Total cost
Profit = Total revenue –Economic cost
Profit is the difference between total revenue and total cost.
Profit = Total revenue – Total cost
Profit = Total revenue –Economic cost
• ECONOMIC COST of any
resource is the value or worth
it would have in its best
alternative use
• FIRM’S ECONOMIC COST –
those payments a firm must
make, or incomes it must
provide, to resource suppliers
to attract the resources away
from alternative production
opportunities.
Economic costs are the sum of
Explicit Costs
• Money payments a firm must
make to non-owners of the firm
for the resources they supplied.
Implicit Costs
• Opportunity costs of firm’s own
resources or money payments
the self-employed resources
could have earned in their best
alternative use.
Implicit Costs: examples
• The firm’s opportunity cost of using the capital it owns is called the
implicit rental rate of capital
• The implicit rental rate (of capital) is the rental income that the firm
forgoes by using its own capital and not renting it to another firm.
The firm implicitly rents the capital from itself.
• The implicit rental rate of capital is made up of
– 1. Economic depreciation
– 2. Interest forgone (rental income forgone)
– Economic depreciation is the change in the market value of capital
over a given period.
– Interest forgone is the return on the funds used to acquire the capital.
The same as the opportunity cost to the firm of using its own capital.
Implicit Costs: examples, cont’d
A firm’s owner often supplies
entrepreneurial ability, and also
works for the firm. The opportunity
cost of the labour supplied is the
income that the owner could have
earned in the best alternative job.
– The return to entrepreneurship is
profit.
– The profit that an entrepreneur
can expect to receive on average
is called normal profit.
– Normal profit is the cost of
entrepreneurship and is a cost of
production.
• Normal profit is the average
return for supplying
entrepreneurial ability, and is an
opportunity cost to the firm.
• Positive Economic Profit is
earned when the return to
entrepreneurial ability is greater
than normal
• Negative Economic Profit (Loss) is
made when the return to
entrepreneurial ability is less
than normal
Economic (opportunity) Costs
Profits to an
Economist
Profits to an
Accountant
Economic
Profits
Implicit costs
(including a
normal profit)
Explicit
Costs
Accounting
Profits
Total
Revenue
Accounting
costs (explicit
costs only)
The Long Run and the Short
Run
• Long Run – a period of time long enough
to enable producers to change the
quantity of all resources they employ
• In the Long Run
– By definition, the firm can vary the
inputs as much as it wants.
– All inputs are variable.
The Long Run and the Short Run
• Short Run is a period of time in which
producers are able to change the quantities of
some but not all the resources they employ
• In the short run:
– Flexibility is limited.
– Some factors of production cannot be
changed.
– Generally, the production facility (“the
plant”) is fixed in the short run
Short-Run Production Relationship
• Total product (TP or Q) is
the number of units of the
good or service produced
by a different number of
workers.
• Marginal product is the
additional output that will
result from an additional
worker, other inputs
remaining constant.
Short-Run Production Relationship
Average product (the same as
labour productivity) is calculated by
dividing total output
by the number of workers who produced it.