The Costs of Production
Chapter 8 (155-156)
Mr. Henry
AP Economics
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Behavior of Producers…
 One
of the big questions facing
producers is what economic resources
to obtain and what to produce with
these resources?
2
Economic Cost…
 When
society uses a combination of
resources to produce a particular
product, it gives up all other alternative
uses of that resource. This is known as
the economic cost, or opportunity cost.
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If you were the owner of an
industry, what would you use
your steel for?
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Explicit vs. Implicit Costs
 Explicit
Costs are the monetary payments
(expenditures) it makes to those who supply
labor services, materials, fuel, transportation.
Payments for the use of resources owned by
others.
 Implicit costs are the opportunity costs of
using its self-owned, self-employed resources.
Implicit costs are the money payments that
self-employed resources could have earned in
their best alternative use.
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Example:
Mr. Henry opens a daycare. Yes, it
may seem like I make more money
being my own boss & owner, but I have
explicit costs & my implicit costs are my
foregone costs like rent, wages, etc.
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Normal Profit
 The
payment made by a firm to obtain and
retain entrepreneurial ability; the minimum
income entrepreneurial ability must receive to
induce it to perform entrepreneurial functions
for a firm.
 Normal profits are considered an implicit cost
because they are the minimum payments
required to keep the owner’s entrepreneurial
abilities self employed. So in my example,
maybe my ability is worth $10,000.
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Economic or pure profits are total revenue less all
costs (explicit and implicit including a normal profit).
Economic Profit = TR-EC
EX. On next page: economic profits are $24,000
(after $63,000EP + $33,000IP are subtracted from
$120,000TR).
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9
Practice…
Gomez runs a small pottery firm. He hires one helper at
$12,000 per year, pays annual rent of $5,000 for his shop, and
spends $20,000 per year on materials. He has $40,000 of his
own funds invested in equipment (pottery wheels, kilns, and so
forth) that could earn him $4,000 per year if alternatively
invested. He has been offered $15,000 per year to work as a
potter for a competitor. He estimates his entrepreneurial talents
are worth $3,000 per year. Total annual revenue from pottery
sales is $72,000. Calculate accounting profits and economic
profits for Gomez’s pottery.
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Practice…
Explicit costs: $37,000 (= $12,000 for the helper + $5,000 of
rent + $20,000 of materials). Implicit costs: $22,000 (= $4,000
of forgone interest + $15,000 of forgone salary + $3,000 of
entreprenuership).
Accounting profit = $35,000 (= $72,000 of revenue - $37,000
of explicit costs); Economic profit = $13,000 (= $72,000 $37,000 of explicit costs - $22,000 of implicit costs).
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Example of production in the
 Imagine the room you are in is a
short run

cookie factory
The fixed input is the production
facility and it includes refrigerators,
bowls, mixers, ovens, tables and
other stuff. The variable input will
be labor. In a short run, the
production period is so short that
only the variable inputs (usually
labor, materials, and other resources)
to the plant can be changed
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What are examples of
variables in the short run at
your place of employment?
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Long Run…
 The
long run is the period long enough
for it to adjust the quantities of all the
resources that it employs, including
plant capacity.
 The long run is a “variable-plant
period” meaning that new buildings or
new equipment can be added.
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What are examples of the long
run at your place of
employment?
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