The Meaning of the Cost• A firm’s cost of production includes all the

opportunity costs of making its output of goods and services

• Economic Cost or Opportunity Cost– Forgoing the opportunity to produce

alternative goods and services.• Explicit Cost

– Accounting cost or money outlay.• Implicit Cost

– Cost measured by the value of alternative given up.

Economic Profit versus Accounting Profit• Your Economists measure a firm’s economic

profit as total revenue minus total cost, including both explicit and implicit costs.

• Accountants measure the accounting profit as the firm’s total revenue minus only the firm’s explicit costs.

• When total revenue exceeds both explicit and implicit costs, the firm earns economic profit.– Economic profit is smaller than accounting profit

Opportunity Cost and Normal Profit• Normal Profit

– Opportunity cost of capital and enterprise.– This is the level of profit that is necessary for a firm to

remain in a competitive industry.

The Use of Accounting Profits and Economic Analysis

Accounting Profit Implicit Cost(Including Normal

Profit)

Accounting Costs = Explicit Costs

Accounting Costs = Explicit Costs

Economic Profit

Economic Cost = Implicit Cost + Accounting Cost

Total Revenue

Cost In The SHORT TERM• Short Term - one year or less, often used to

refer to bonds or loans.

• Long Term - long period of time, as for a bond (10 or more years) or for a buy and hold investment strategy.

Cost Defined• Total Cost (TC)

– The sum of all the cost of production for a given level of output.

• Total Fixed Cost (TFC)– The cost of the fixed factors of production. Total fixed

cost does not vary in the short run.

• Total Variable Cost (TVC)– Total of cost that vary directly with output, increasing

as more output is produced.

Cost Defined• Average Total Cost (AC)

– Total costs of production divided by the number units of output.

AC = TC Q

• Average Fixed Cost (AFC)– Total fixed costs of production divided by output.

Average fixed costs decline as production is increased.

• Average Variable Cost (AVC)– Total variable cost divided by the number of units of out

put.

Cost Defined• Marginal Cost (MC)

– Change in total cost from producing some more (or less) unit output.

∆ MC =

Cost Curves• Co

The Relationship Between Product Curves And Cost Curves

Alternative Plant Sizes

Long run Average Cost Curve

Economies and Diseconomies of Scale

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