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Title: Microeconomics-The cost of production
Description: Concept of cost. components of economic cost. private cost and social cost. total cost. average costs. marginal cost. microeconomics.
Description: Concept of cost. components of economic cost. private cost and social cost. total cost. average costs. marginal cost. microeconomics.
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LECTURE 5: THE COSTS OF PRODUCTION
Learning Outcomes
By the end of the lecture, students should be able to
Describe several concepts of firms and economic
costs
Draw the curves of short-run costs
Explain the curves of short-run costs
1
PRODUCTION PROCESS AND FIRMS
•
Production is any activity or process of
combining inputs to transform into outputs that
produce utility at present time or in the future
...
2
CONCEPT OF COST
•
Generally, costs are matters that must be
exchanged or sacrificed in order to obtain
something else in return
...
3
CONCEPT OF COST
•
Economic costs for a good can be defined as
the value of the best alternative foregone in
order to obtain the particular good
...
4
COMPONENTS OF ECONOMIC COSTS
Economic Costs
Private Costs
Social Costs/
External Costs
5
PRIVATE COSTS AND SOCIAL COSTS
•
Private cost is the cost that has to be paid by an
individual who is directly involved in the
production or consumption of a particular
good
...
7
EXPLICIT COSTS AND IMPLICIT COSTS
•
Explicit cost is the market value of all inputs
purchased by a producer
...
8
SHORT-RUN PRODUCTION COSTS
•
Fixed costs are costs that do not change
according to change in output
...
9
TOTAL COST
•
Total Cost of a firm is the economic cost of the
firm
...
•
Total cost = Total Fixed Costs + total Variable
Costs
•
TC = TFC + TVC
10
•
Total Variable Cost = Total Cost – Total Fixed
Cost
•
TVC = TC - TFC
11
TABLE 1: TOTAL COSTS BASED ON ASSUMPTION r= RM25
per unit of capital, and w = RM10 per unit of labour
FC
VI (L)
OP
TFC
TVC
TC
AFC
AVC
AC
MC
2
0
0
50
----
50
-----
------
------
------
2
1
5
50
10
60
10
2
12
2
2
2
15
50
20
70
3
...
33
4
...
00
2
3
30
50
30
80
1
...
00
2
...
67
2
4
50
50
40
90
1
...
80
1
...
50
2
5
75
50
50
100
0
...
67
1
...
40
2
6
95
50
60
110
0
...
63
1
...
50
12
FIGURE 1: TOTAL COST CURVE, TOTAL FIXED COST
CURVE AND TOTAL VARIABLE COST CURVE
•
C
TC
•
•
•
50
VC
FC
Q
13
AVERAGE COSTS
•
Average Fixed Cost = Total Fixed Cost/Total
output
•
AFC = TFC/Q
•
Average Variable Cost = Total Variable Cost/
Total Output
•
AVC = TVC/Q
14
•
Total Average Cost = Total Cost / Total Output
•
AC = AFC + AVC
15
MARGINAL COSTS
•
Marginal cost is the change in total cost caused
by one unit of output change, or
•
Marginal Cost = Change in Total Variable
Cost/Change in Total Output
•
MC =
16
FIGURE 2: AVERAGE COST AND MARGINAL COST
CURVES
AC
•
•
•
MC
AVC
•
•
•
AFC
Q
17
•
Average fixed cost will continually decline but
does not reach zero due to the value of fixed
cost divided by total output that is increasing
...
18
•
Due to the continually decreasing average
fixed cost, the distance between AC and AVC
becomes narrower when output increases
...
After one point, the increase in AVC gives
a bigger effect compared to the
decrease of AFC
...
21
•
Marginal cost (MC) decreases along
with AVC at the early stage of
production but increases after one
point due to the law of diminishing
returns
...
22
MC intersects AC and AVC at the minimum point
of AC because if marginal or addition is lower
than average, average will decline
...
Average cost will increase if marginal cost is
higher and the contrary if marginal cost is lower
than the average cost
...
Because MC = w/MP, hence MP is maximum
when MC is minimum, and vice versa
...
This can be shown by an example
...
But also, AVC = w/AP = RM10/2 = RM5
...
25
•
Due to increasing orders, another worker is
hired with same wage, RM 10
...
•
Hence marginal product is change in total
product/ change in labour = 4/1 = 4
•
Marginal cost is MC = Change in Total Cost/
Change in Total Quantity = RM 10/ 4 = RM2
...
•
26
FIGURE 3: RELATIONSHIP BETWEEN COST AND
PRODUCTION IN SHORT-RUN
MP
AP
AP
L
MC
AC
MC
AC
Q
27
ECONOMIC PROFITS VERSUS ACCOUNTING
PROFITS
Profit is the difference between total revenue (TR) with
total cost (TC)
...
Accountant only consider the explicit costs and hence the
profit calculated is referred as the accounting profit
...
Implicit cost refers to opportunity cost
...
But, he decided to start a small business by withdrawing
his savings of RM50,000 to be used as the capital
...
The rental of a shop house was RM600 per month and hired
two workers with the salary of RM700 each per month
...
30
Total revenue
Minus Explicit cost:
Shop rental (RM600 x 12 months)
Wage (RM700 x 2 workers x 12 months)
Necessary equipment
Total explicit cost
Accounting profit (Total revenue minus explicit cost)
Minus implicit cost: salary received
Reurns to savings, 10% from RM50,000
Total Implicit cost
Economic profit (Total revenue – Total costs)
RM
7,200
16,800
40,000
RM
120,000
64,000
56,000
15,000
5,000
20,000
36,000
31
EXERCISE
Based on the data below, answer the questions
...
Qty
TVC
0
0
1
180
2
240
3
270
4
315
5
420
6
630
TFC
TC
MC
AC
AVC
AFC
360
32
EXERCISE
Based on the data below, answer the questions
Title: Microeconomics-The cost of production
Description: Concept of cost. components of economic cost. private cost and social cost. total cost. average costs. marginal cost. microeconomics.
Description: Concept of cost. components of economic cost. private cost and social cost. total cost. average costs. marginal cost. microeconomics.