By: Christopher Mazzei

Costs to Consider

Viewpoints• The owner of a company wants to keep costs

down.

• An employee of the company wants a high wage or salary.

• There is always a permanent balancing act between employer and employee(s).

Profit

• The firm is concerned with keeping costs down so that its generated revenue is greater than its total costs.

• Profit = Total Revenue – Total Cost• Explicit costs are costs that require the outlay of

money. For instance, the explicit cost of a year of college is the tuition.

• Implicit costs are instead the value of the benefits that are given up. For instance, the implicit cost of a year in college is the income that you would have earned if you had gotten a job instead.

Accounting Vs. Economic Profit

• Accounting Profit = the business’s total revenue minus the explicit cost and depreciation value.

• Economic Profit = the business’s total revenue minus the opportunity cost of its resources (Total Revenue minus (Explicit costs + Implicit costs).

• Normal Profit – when a firm’s economic profit equals zero (the firm is making just enough profit to stay in business and to continue producing at the same level)

Types of Costs• Total Fixed Costs - costs that do not vary with output TFC• Total Variable Costs - costs that vary with the rate of production TVC• Average Fixed Costs = total fixed costs divided by the # of units

produced AFC• Average Variable Costs = total of variable costs divided by the # of

units produced AVC• Average Total Costs = total costs divided by the # of units produced

ATC• Marginal Costs = change in total costs due to a change in

production of one unit MC = change in TC /change in Q• Total Costs = Fixed Costs + Variable Costs TC

Fixed Costs

• Costs that remain constant whether you produce 0 units or millions of units of a product.

• The rent on the land your business resides is considered a fixed cost, the loan payment if you build a factory is a fixed cost, salary workers are fixed costs, and your business license is a fixed cost. These payments will remain constant no matter how many units are produced.

• In the short run, fixed costs cannot be altered. In the long run however, all costs are variable.

Variable Costs

• Costs that change whether you produce 1 unit or millions of units of a product.

• Variable costs change as you increase production, starting with the first unit.

• The cost of raw materials to produce/sell your product, your firms electricity usage, your phone bill and your office supplies expenses are all variable costs that increase as your company’s output increases.

Total Cost Graph

Average Cost Graph

Returns to Scale

• Economies of Scale – when a firm’s long-run average total cost declines as it’s output increases.

• Increasing Returns to Scale – when output increases more than in proportion to an increase in all inputs

• Diseconomies of Scale - when a firm’s long-run average total cost increases as it’s output increases.

• Decreasing Returns to Scale – when output increases less than in proportion to an increase in all inputs.

• Constant Returns to Scale – when output increases directly in proportion to an increase in all inputs

Sunk Costs• Sunk Cost – a cost

that has already been incurred and cannot be recovered.

• Sunk costs should be ignored in a decision about future actions because they have no influence on future costs and benefits.

MR = MC• The point at which Marginal Revenue equals the

Marginal cost. When displayed on a graph it shows the Profit-maximizing quantity of output at the market price.

Exam Questions1. As its output increases, a firm’s short-run marginal cost will eventually increase because of(a) diseconomies of scale(b) a lower product price(c) inefficient production(d) the firm’s need to break even(e) diminishing returns

7.For a firm hiring labor in a perfectly competitive labor market, the marginal revenue product curve slopes downward after some point because as more of a factor is employed, which of the following declines?(a) Marginal product(b) Marginal factor cost(c) Marginal cost(d) Total output(e) Wage rates

8.Which of the following is always true of the relationship between average and marginal costs?(a) Average total costs are increasing when marginal costs are increasing.(b) Marginal costs are increasing when average variable costs are higher than marginal costs.(c) Average variable costs are increasing when marginal costs are increasing.(d) Average variable costs are increasing when marginal costs are higher than average variable costs.(e) Average total costs are constant when marginal costs are constant.

Exam Questions Cont.

Links to Real World Costs!

• http://www.networkworld.com/news/2009/012609-companies-cutting-costs.html

• https://power2switch.com/static/cases/mcdonalds.pdf