The Costs of Production
• Explicit and Implicit Costs
– Explicit Costs: Money payments that a firm makes
for the use of resources owned by others (labor,
materials, fuel, etc.)
– Implicit Costs: The opportunity costs of selfowned resources. The value of the next best thing
you could do with your labor, time, tools,
entrepreneurial talent, etc. Things you could have
gotten paid to do.
Walt and Jesse make peanut brittle in their lab.
Explicit Costs: the equipment, electricity, the
ingredients, rent for the building, transportation to
ship the product, etc.
Implicit Costs: all the money they could have
made cooking something else in the lab.
Accounting Profit, Normal Profit, and Economic Profit
Accounting Profit – Business makes enough to cover its
explicit costs. Any more is accounting profit.
Normal Profit – business makes enough to cover its
explicit costs plus implicit costs, including enough to
pay the entrepreneur an amount equal to what he or
she could make running a business of a similar scope.
Economic Profit – profit over and above normal profit.
It is an added reward to the entrepreneur and what
lures new companies into an industry.
Jesse: “This is awesome, Mr. White. We spent $2000
on ingredients and materials, $10,000 to rent the lab
and equipment for the month. We sold our peanut
brittle for $20,000. That’s an $8000 profit!”
Walt: “Jesse you’re an idiot!!! …”
Short Run vs. Long Run
• Short run: To little time for a firm to change its
plant capacity, but enough to change
production levels by varying the amounts of
resources (material, labor, etc.).
• Long Run: Enough time for a firm to alter
plant capacity. For an industry, it’s also
enough time for new firms to enter the
business or existing firms to exit.
• Short run = Fixed Plant
• Long Run = Variable Plant
Short-Run Production Relationships
• Total Product (TP) – Total quantity produced.
• Marginal Product (MP) – The extra output
achieved by adding one more unit of some
variable resource (one more worker, one more
bag of peanuts, one more barrel of molasses)
• Average Product (AP) – Output per unit of labor.
– So if we have 20 employees and produce 100 tons of peanut
brittle, our average output is 5 tons.
Law of Diminishing Returns
• As more and more variable resources are
added, additional production gains will
eventually decline.
Homework
• Just make sure both of the Chapter 9
reading assignments you’ve gotten so far
are done for tomorrow.
# of Lawns Cut/Day
30
Total Product
20
Area of increasing
marginal returns.
10
Area of decreasing
marginal returns.
0
1
2
7
3 4 5 6 7 8 9 10 11 12
Quantity of Labor (# of workers)
Average Product
0
Marginal Product
-3
1
2
3
4
5
6
7
8
9
10 11 12
Area of negative
marginal returns.
550
Total Cost
500
450
Total Variable
Cost
400
350
300
250
200
150
Total
Fixed Cost
100
50
0
1
2
3
4
5
6
7
8
9
10
550
500
A
450
B
Cost ($)
400
350
300
250
200
150
C
100
50
0
1
2
3
4
5
6
Quantity (units)
7
8
9
10
550
Total Cost
500
450
Cost ($)
400
350
300
250
200
150
100
50
0
1
2
3
4
5
6
Quantity (units)
7
8
9
10
105
100
MC2
90
MC1
Cost ($)
80
70
ATC2
60
50
ATC1
40
30
20
10
0
1
2
3
4
5
6
Quantity (units)
7
8
9
10
105
100
90
Cost ($)
80
70
AVC2
60
50
40
AVC1
30
20
?
10
0
1
2
3
4
5
6
Quantity (units)
7
8
9
10