The Costs of Production Mr. Raposo

What is a business? Business: An enterprise that brings individuals, financial and economic resources to produce goods or services. Sole Proprietorship: A business owned by a single person. Partnership: A business owned by two or more people. Corporation: A company given legal status apart from its owners. Ownership in a corporation is gained (loss) by buying (selling) shares.

What is Production? Production: The process of transforming our resources (inputs) into a good or service with economic value (output). Inputs: Resources used in production Output: The quantity of a good or service that results from production

Labour Intensive vs. Capital Intensive Processes Labour-intensive process: Employs more labour less capital in its production process Capital-intensive process: Employs more capital and less labour in its production process.

Example of Productive Efficiency fig. 4.2 ProcessWorkers (labour) Sewing Machines (capital) Total T-shirts Produced per day A42250 B33 Capital Intensive Labour Intensive

Productive Efficiency Productive Efficiency: Producing a certain quantity of output at the lowest cost. Example: Worker in previous example costs $100/day. The cost of the machine is $25 day. Which production process is more efficient?

Exercise: Measure Productive Efficiency ProcessWorkers (labour) $100/day Sewing Machines (capital) $25/day Cost per day for labour Cost per day for machines Total Cost A42 B33

Answer: Measuring Productive Efficiency ProcessWorkers (labour) $100/day Sewing Machines (capital) $25/day Cost per day for labour Cost per day for machines Total Cost A42$400$50$450 B33$300$75$375

Economic Costs vs. Accounting Costs Economic Costs: Include both Explicit and Implicit costs Explicit Costs: Expenses such as payment for material, wages, rent, etc. These costs appear on a business firm's accounting records. Implicit Costs: These costs not included among expenses on the accounting records of a business firm. They are estimates of what the owner’s “give up” by being involved in the business.

Economic Profit Economic Profit = Total revenue – economic costs Remember, Total Revenue (TR) = Price (P) x Quantity(Q)

Accounting Profit Excludes implicit costs Accounting Profit = Total revenue-Explicit Costs

Example: Widget company has total revenue of $200,000. Accountants determine explicit costs to be $150,000. The owner, Mr. R, of widget co. has invested $80,000 of his own money that could earn 10% on $80,000 if invested. Mr. R could also be earning at least $45,000 as a manager at his previous work. Calculate accounting and economic profit.

Exercise Calculate Accounting and Economic Profit

Example: Widget company has total revenue of $200,000. Accountants determine explicit costs to be $150,000. The owner, Mr. R, of widget co. has invested $80,000 of his own money that could earn 10% on $80,000 if invested. Mr. R could also be earning at least $45,000 as a manager at his previous work. Calculate accounting and economic profit.

Accounting Profit = Total Revenue – Explicit Costs = $200,000 - $150,000 = $50,000

Economic Profit = Total Revenue – Economic Costs = Total Revenue – (Explicit + Implicit Costs) = $200,000 – ($150,000+$8,000+$45,000) = $200,000 – $203,000 = -$3,000 (a loss) (Interest Calculated as: $80,000 x 10% = $8,000)

Homework: p. 121#1-5

Production in the Short-Run Short-run: A period of time too short for a business to alter its plant capacity, but long enough to vary the degree to which this capacity is utilized. Long-run: A period of time long enough to permit a firm to vary the capacity of the plant as well as the degree of its use.

Using Resources Fixed Inputs: Inputs that cannot be adjusted in the short run. (ex: Size of machine or factory) Variable Inputs: Inputs that can be adjusted in the short run. (ex: labour and materials)

Total, Average and Marginal Product Total product = q (quantity of output) Average product = total product (q) (AP)# of workers (L) Marginal product = q L

Calculate and Graph Calculate and total, marginal and average product Graph total product on a separate graph Graph marginal and average product together on a separate graph below the total product graph Refer to text fig.4.4 p. 106

Fig. 4.3 Production in the Short Run LabourTotal Product Marginal Product Average Product

Fig. 4.3 Production in the Short Run LabourTotal Product Marginal Product Average Product

The Costs of Production Fixed, Variable & Total Costs Per Unit Costs (or Average Costs) Marginal Costs

Law of Diminishing Marginal Returns Law of diminishing marginal returns: At a certain point, the addition of a variable input to a fixed input causes the marginal product to decrease.

Law of Diminishing Marginal Returns Example: Class activity for Mr. R’s widget co.

Short Run & Long Run Short Run- a period in which at least one of a firm’s resources is fixed (plant capacity) Output can be varied by increasing labour, materials & other resources but plant capacity is fixed Long Run- a period in which all resources are variable, including plant capacity

Fixed, Variable & Total Costs Fixed Costs = Costs that do not vary with output Variable Costs = Costs that vary with output Total Costs = Fixed + Variable Costs

Per Unit or Average Costs Average Fixed Costs (AFC) = TFC Q Average Variable Costs (AVC) = TVC Q Average Total Costs (ATC) = TFC+TVC Q

Marginal Cost Marginal Cost (MC): the additional cost of producing one more unit of output. Marginal Cost = Change in Total Cost Change in Q

Application Calculate and graph marginal cost, average cost, average variable costs and average fixed costs Refer to text p. 111

Short-run costs: Enter formula in first row LabourTotal Product Marginal Product Fixed Costs Variable Costs Total Costs Change in Total Costs Marginal Costs Average Fixed Costs Average Variable Costs Average Cost