Costs
Curves
Diminishing Returns
•Accounting Costs
•Economic Costs
•Supply
ACCOUNTING COSTS
• Accounting costs are
monetary (usually
explicit).
• Accounting profit =
Revenue – Accounting
costs.
ECONOMIC COSTS
• Economic costs = accounting costs + opportunity costs.
• Economic profit = revenue – economic costs.
• Economic profit = revenue – (accounting costs + opportunity costs).
ECONOMIC COSTS
• Economic costs = accounting costs + opportunity
costs.
•
• In economic analysis we use economic costs.
• To make a wise decision we need to consider all
costs and not only monetary costs.
• Opportunity costs should be considered as they
have an important bearing on our decision making.
These include opportunity cost for resources
owned by the firm itself.
OPPORTUNITY COSTS
• Bill owns a farm worth $1m. His yearly revenue is $100,000 and his
expenses are $60,000. The current interest rate is 5% for savings.
What is Bill’s accounting profit and what is his economic profit?
Accounting profit
$$40,000
Economic profit
-($10,000)
OPPORTUNITY COSTS
• Chen runs her own business. She receives no wage or salary. She
could work full-time for $25,000pa. Her business revenue for last
year was $30,000 and her expenses $10,000. What is her
accounting profit and her economic profit?
Accounting profit
$20000
Economic profit
-($5000)
OPPORTUNITY COSTS
• Tao must travel from
Wellington to Auckland
for business. Tao is paid
$20 per hour and he
must travel in work
time. Prices and times
are:
Which is
cheapest?
Mode
Price $ Hours
Plane
$150
1
Car
$100
6
Bus
$70
10
Plane is cheapest. If we consider
opportunity costs, total cost for plane
travel is $170 – much cheaper than the
other options.
Economic costs in more detail
• Rent- Economic return to land (return to any factor
that is in fixed supply)
• Wages- Economic return to labour. It includes all
ways people a compensated for providing their time,
efforts and skills. (except for enterprise)
• Interest- Economic return on capital.
• Profit- Economic return to enterprise for taking risk.
It is the reward to those who run the risk of failure
when they bring together all the other factors of
production
Do this Now
• Last year Mona had a job as a manager for a fishing company,
which paid her $65,000 a year,
• She had $80,000 in savings, which gave her a rate of return of
10%.
• She thought she could do better by going fishing herself, so
gave up her job and invested $80,000 of her own money in
buying a fishing boat and quota.
• By the end of the first year she had sold $140,000 worth of fish
and her costs of running the business had been $70,000. She
expected the costs to be quite high in the first year, because
she was getting the business established, but though these
would fall in future years.
•
•
•
1. Calculate her accounting profit
2. Calculate her economic profit
3. Which are always greater? Economic or accounting profits? Explain
Answers!
• 1. Calculate her accounting profit
Revenue - Accounting costs
140,000 – 70,000 = 70,000
• 2. Calculate her economic profit
Revenue – Economic Costs (accounting costs +
opportunity costs)
140,000 – 70,000 – 65,000- (80,000 x0.10) = -3000
• 3. Which are always greater? Economic or accounting
profits? Explain
• Accounting profits are equal to Revenue minus
accounting costs. Economic profits are equal to revenue
minus accounting costs and opportunity costs. Thus
Accounting profits will always be greater than Economic
profits due to economic profits taking into account an
extra cost, opportunity costs.
Fixed costs are costs that
do not vary with output
Q
FC VC
0 100
1 100
2 100
3 100
TC
Fixed costs are costs that
do not vary with output
Variable costs are costs
that increase as output
increases
Q
FC
VC TC
0
100
1
100 30
2
100 50
3
100 80
0
Fixed costs are costs that
do not vary with output
Q
FC
VC TC
Variable costs are costs
that increase as output
increases
0
100
1
100 30 130
Total costs = Fixed +
Variable costs
2
100 50 150
3
100 80 180
0 100
FC, VC & TC
Fixed costs are
costs that do not
vary with output
TC
Costs($)
Variable costs are costs
that increase as output
increases
Total costs = Fixed +
Variable costs
VC
FC
Quantity
Average and Marginal Cost
Outpu
t (Q)
0
Total
Cost
100
Average Marginal
Cost
Cost
-
1
200
200
100
2
320
160
120
3
420
140
100
4
640
160
220
5
1100
220
460
AC = TC/Q
Average and Marginal Cost
Outpu
t (Q)
0
Total
Cost
100
Average Marginal
AC = TC/Q
Cost
Cost
MC = TC2 - TC1
200
100
1
200
2
320
160
120
3
420
140
100
4
640
160
220
5
1100
220
460
Starter Activity
Number of people in the Total Product
group (Workers)
Marginal Product
1
2
3
4
We will assume all groups are equally skilled, so the
marginal product is the difference between group one’s
total and group two’s total product.
Graph the number of workers on the horizontal axis
against the number of blocks sorted on the vertical axis.
What do you notice?
Short-run costs
The short run, which our particular concern, is a period when
at least one input to the production process is fixed.
This means that in the short run all production will be subject
to the law of diminishing return.
fig
In economics we distinguish between various time periods - ie
short and long run.
Diminishing Returns
The law of diminishing returns states that where
additional units of a variable input are added to a fixed
amount of another input, the additional output, or
marginal product, will eventually fall.
Diminishing Returns
Fixed Input
Capital
Cement Mixer
Variable Input
Labour
Bricklayers
AC
TP (Q)
MP
Returns
(per brick)
MC
(per brick)
1
0
0
1
1
70
70
Increasing
6
6
1
2
210
140
Increasing
4
3
1
3
420
210
Increasing
3
2
1
4
630
210
Constant
2.67
2
1
5
770
140
Diminishing
2.73
3
1
6
840
70
Diminishing
Fixed
Input
Variable
input
3
The additional output(MP)
eventually falls
6
The Shape of the MC curve
Costs($)
MC decreases
initially because
of increasing
returns
MC
Note: always
plot the MC
curve at the
mid-point!
MC increases
because of
diminishing
returns
Quantity
The Shape of Average Cost
Curves
Costs($)
FC are constant so AFC will
continually decline as FC are
spread over increasing output
FC
AFC
Quantity
The Shape of Average Cost Curves
Costs($)
AC
decreases
because of
short run
economies:
AC
•Technical
•Marketing
AFC
•Managerial
•Financial
Quantity
The Shape of Average Cost Curves
Costs($)
AC increases
as short run
diseconomies
set in.
AC
AFC
Quantity
The Shape of Average Cost Curves
Costs($)
The difference
between AC
and AVC is
equal to AFC
AC
AVC
AFC
Quantity
Marginal Cost & Average Cost
Costs($)
MC
AC
If MC<AC
then AC will
be decreasing
Quantity
Marginal Cost & Average Cost
Costs($)
MC
AC
If MC>AC
then AC will
be increasing
Quantity
Marginal Cost & Average Cost
Costs($)
MC
AC
MC cuts AC
at its
minimum
point - this is
the technical
optimum
Quantity
Marginal Cost & Average Variable Cost
Costs($)
MC also cuts
AVC at its
minimum
point
MC
AC
AVC
Quantity
Break Even & Shut Down
Costs($)
A firm must
cover AC if it
is to break
even
Break even point
is where AR=AC.
Where the price is
enough to cover
all costs and the
firms make
normal profits.
MC
AC
AVC
This is the break
even point
Quantity
Break Even & Shut Down
Costs($)
In the SR a
firm can
survive if
P > AVC
MC
AC
AVC
This is the shut
down point
Quantity
A firm’s Supply
curve is derived
from the MC
curve above the
shut-down point
Why do you
think the
supply curve is
upwards
sloping?
The Supply Curve
Costs($)
MC =S
AC
AVC
Because of diminishing
returns!
Producing higher levels
of output results in
progressively less
efficient resource
combinations. Because
of this the firm will
only supply a larger
quantity at higher
prices.
Quantity