Unit 5 - Cost Functions
• Explicit Costs and Implicit Costs
Explicit cost are out-of-pocket expenses, such as
labor, raw materials,
and rent.
Implicit costs are foregone
expenses, such as the value of
your own time, and the value of your own money
(interest earned).
Microeconomics
Which of the following comes closest to
the true economic cost (on average) of
earning a bachelor’s degree in college?
1.
2.
3.
4.
5.
0 of 5
$10,000
$20,000
$40,000
$60,000
$160,000
Unit 5 - Cost Functions
Estimated explicit costs of attending college
(4 years):
tuition, fees, books, and transportation:
$15,000 x 4 = $60,000 .
Estimated implicit costs include foregone
earnings, and foregone interest:
$25,000 x 4 = $100,000.
Total economic cost: $160,000.
Microeconomics
Unit 5 - Cost Functions
• Economic versus Accounting Profits
Economic profits equal total revenue minus
all (explicit and implicit) costs.
Accounting profits equal total revenue minus
explicit costs.
Microeconomics
If a firm’s total revenue is $80,000, and its explicit
and implicit costs are $50,000 and $25,000,
respectively, then its economic and accounting
profits are:
1.
2.
3.
4.
5.
$5,000; $25,000
$5,000; $30,000
$30,000; 5,000
$30,000; $25,000
$75,000; $80,000
Unit 5 - Cost Functions
• Economic versus Accounting Profits
Calculations
Economic Profit
Accounting Profit
= $80,000 - $75,000
= $5,000
= $80,000 - $50,000
= $30,000
Microeconomics
Unit 5 - Cost Functions
• Economic versus Accounting Profits
Example 2:
If a firm’s total revenue is $80,000, and its
explicit and implicit costs are $70,000 and
$25,000, respectively, what are its economic
and accounting profits?
Microeconomics
Unit 5 - Cost Functions
• Economic versus Accounting Profits
Example 2 answer
Economic Profit
= $80,000 - $95,000
= - $15,000
Accounting Profit
= $80,000 - $70,000
= $10,000
From a financial point of view, should the firm
continue to operate?
Microeconomics
Unit 5 - Cost Functions
•
Total and Per Unit Costs
Total and per unit economic costs include:
– Total Variable Cost (TVC)
– Total Fixed Cost (TFC)
– Total Cost (TC)
– Average Variable Cost (AVC)
– Average Fixed Cost (AFC)
– Average Total Cost (ATC)
– Marginal Cost (MC)
Microeconomics
Unit 5 - Cost Functions
•
Total and Per Unit Costs
Example 1
If TVC + TFC = TC, and TVC and TFC are
$900 and $300, respectively, what is TC?
Microeconomics
Unit 5 - Cost Functions
• Total and Per Unit Costs
Example 1 answer
Total Variable Cost
Total Fixed Cost
$900
$300
+
Total Cost
+
$1200
Microeconomics
Unit 5 - Cost Functions
•
Total and Per Unit Costs
Example 2
If TC is $1,200 and production is 50, what is
ATC?
Microeconomics
Unit 5 - Cost Functions
• Total and Per Unit Costs
Example 2 answer
ATC =
TC
$1200
=
Q
= $24
50
Microeconomics
Unit 5 - Cost Functions
• Total and Per Unit Costs
Example 3
If production is 50, and total variable and total
fixed cost are $900 and $300, respectively,
what are average variable cost and average
fixed cost? (Output = 50).
Microeconomics
Unit 5 - Cost Functions
• Total and Per Unit Costs
Example 3 answer
Average variable cost
$900
=
=$18
50
Average fixed cost
=
$300
50
=$6
Microeconomics
Unit 5 - Cost Functions
• Total and Per Unit Costs
Example 4
Using the data in the previous examples, let’s
say that you produce an additional 5
products, and your total cost rises to $1260,
what is your marginal cost?
Microeconomics
Unit 5 - Cost Functions
• Total and Per Unit Costs
Example 4 answer
Marginal cost =
change in total cost
$60
=
change in production
= $12
5
Microeconomics
Unit 5 - Cost Functions
• Cost Calculations
Example 5 - Fill in the missing values
Q
TC TVC TFC ATC AVC AFC MC
0
80
1
2
3
4
80
110
70
90
Microeconomics
Unit 5 - Cost Functions
• Short-run Cost Calculations
Example 5 answer
Q
TC TVC TFC ATC AVC AFC MC
0
80
0
80
-
-
-
-
1
160
80
80
160
80
80
80
2
220 140
80
110
70
40
60
3
290 210
80 96.7 70 26.7 70
4
380 300
80
95
75
20
90
Microeconomics
Unit 5 - Cost Functions
• The Shape of Typical Cost Curves
Costs
in Dollars
MC
ATC
AVC
Quantity
Produced
Unit 5 - Cost Functions
• The Long-run Average Cost Curve
In the long run, all inputs are variable. A firm
has enough time to choose the size of its
factory, farm, office building, or other capital
goods.
The firm can choose from many short-run
cost curves. The bottom points of the shortrun average cost curves make up the longrun average cost curve.
Microeconomics
Unit 5 - Cost Functions
• The Long-run Average Cost Curve
Average
Costs
EOS
DOS
Quantity
Produced
Long-run average costs fall as production first rises.
This is called economies of scale (EOS).
When the firm gets too big, long-run average costs
rise. This is called diseconomies of scale (DOS).
Microeconomics
Unit 5 - Cost Functions
• Returns to Scale
When inputs increase, and production more
than proportionately increases, then we
speak of increasing returns to scale
(associated with economies of scale).
Example
Inputs increase by 10%, and production
increases by 20%.
Microeconomics
Unit 5 - Cost Functions
• Returns to Scale
When inputs increase, and production less
than proportionately increases, then we
speak of decreasing returns to scale
(associated with diseconomies of scale).
Example
Inputs increase by 10%, and production
increases by 5%.
Microeconomics
Unit 5 - Cost Functions
• Returns to Scale
When inputs increase, and production
increases by the same percentage, then we
speak of constant returns to scale.
Example
Inputs increase by 10%, and production
increases by 10%.
Microeconomics