Costs of Production
ECONOMIC COSTS
• COSTS (in Economics) that deal with
forgoing the opportunity to
produce alternative goods and
services.
• The OPPORTUNITY COST of
producing a good is its value or
worth in its best alternative use.
EXPLICIT COSTS
• Explicit costs are those payments
a firm must make, or incomes it
must provide to resource
suppliers to attract these
resources away from alternative
production opportunities.
EXPLICIT COSTS
Examples:
• payments to hired labor
• payments to vendors
• payments for rent or mortgage
• payments for trucks, etc.
IMPLICIT COSTS
•Costs of self-owned, selfemployed resources
•Money payments the selfemployed resources could have
earned in their next best
alterative employments.
IMPLICIT COSTS
Examples:
• value lost by investing in business
instead of alternative investment
• value lost in working for someone else
• value lost by not using entrepreneurial
skill in another way
NORMAL PROFITS
• Amount remaining from revenue less
those costs to attract and retain
resources in a given line of production.
• Minimum return needed by
entrepreneur to stay in business
• If not realized, entrepreneur will
reallocate resources to more attractive
pursuits.
ECONOMIC PROFITS
Total Revenue minus all Costs
•Costs will include both explicit
and implicit costs
•Implicit costs will include the
normal profit
ECONOMIC PROFITS
Economic profits =
Total revenue —opportunity costs of all
inputs
Economic profit is not a cost!
… it is a return in excess of the
normal profit required to retain
the entrepreneur
ECONOMIC
PROFITS
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C O
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Implicit Costs
including
Normal Profit
Explicit Costs
T
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A
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ACCOUNTING
PROFITS
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ACCOUNTING
COSTS
explicit costs
only
• Gomez runs a small firm which makes pottery.
He hires one helper at $12,000 per year, pays
annual rent of $5,000 and materials cost
$20,000 per year.
• Gomez has $40,000 of his own funds
invested in equipment which could have
earned $4,000.
• Gomez has been offered $15,000 to work as a
potter for a competitor. He estimates his
entrepreneurial skills are worth $3,000 per
year.
Explicit Costs?
Implicit Costs?
Explicit costs:
$12,000 + $5,000 +
$20,000 = $37,000
Implicit Costs:
$4,000 + $15,000+
$3,000 = $22,000
• If Total Revenue is $72,000
Accounting Profits
Explicit costs:
$37,000
$72,000— $37,000 = $35,000
Economic Profits
Explicit
costs:$37,000
Implicit
costs:$22,000
$72,000— $37,000—$22,000 = $13,000
Short Run
FIXED PLANT
•Period of time too brief for firm to alter its
plant capacity
•Output can be varied by adding larger or
smaller amounts of labor, materials, and
other resources.
•Existing plant capacity can be used more or
less intensively
Long Run
VARIABLE
PLANT
Period of time long enough to change the
quantities of ALL resources employed,
including plant capacity.
Enough time for existing firms to dissolve
and exit the industry OR for new firms to
form and enter the industry.