BellringerReview: Utility, Marginal

1. Draw a small chart in your notes showing your level of alertness throughout your school day on

a Wednesday. 0 being not alert and 10 being “top of your game

1st 0-10

2nd 0-10

3rd 0-10

4th 0-10

5th 0-10

6th 0-10

Mankiw Chapter 13 Costs

Law of Diminishing Marginal Returns

• Benefit of extra input decreases from the last

• Songs

• Movies

• Video games

• Alcohol

• Being in school

• Studying

• Costs!

THE COSTS OF PRODUCTION

4

Total Revenue, Total Cost, Profit

• We assume that the firm’s goal is to maximize profit.

Profit = Total revenue – Total cost

the amount a firm receives from the sale of its output

the market value of the inputs a firm uses in production

THE COSTS OF PRODUCTION

5

Costs: Explicit vs. Implicit• Explicit costs require an outlay of money,e.g., paying wages to workers.

• Implicit costs do not require a cash outlay,e.g., the opportunity cost of the owner’s time.

• Remember one of the Ten Principles: The cost of something is what you give up to get it.

• This is true whether the costs are implicit or explicit. Both matter for firms’ decisions.

THE COSTS OF PRODUCTION

6

Explicit vs. Implicit Costs: An Example

You need $100,000 to start your business. The interest rate is 5%.

• Case 1: borrow $100,000– explicit cost = $5000 interest on loan

• Case 2: use $40,000 of your savings, borrow the other $60,000– explicit cost = $3000 (5%) interest on the loan– implicit cost = $2000 (5%) foregone interest

you could have earned on your $40,000.In both cases, total (exp + imp) costs are $5000.

THE COSTS OF PRODUCTION

7

Economic Profit vs. Accounting Profit

• Accounting profit = total revenue minus total explicit costs

• Economic profit= total revenue minus total costs (including

explicit and implicit costs)

• Accounting profit ignores implicit costs, so it’s higher than economic profit.

The equilibrium rent on office space has just increased by $500/month.

Compare the effects on accounting profit and economic profit if

a. you rent your office space

b. you own your office space

A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22

Economic profit vs. accounting profitEconomic profit vs. accounting profit

8

The rent on office space increases $500/month.

a. You rent your office space.Explicit costs increase $500/month. Accounting profit & economic profit each fall $500/month.

b.You own your office space.Explicit costs do not change, so accounting profit does not change. Implicit costs increase $500/month (opp. cost of using your space instead of renting it), so economic profit falls by $500/month.

A C T I V E L E A R N I N G A C T I V E L E A R N I N G 22

AnswersAnswers

9

An unsuccessful business

• Costs that they can change tomorrow

• Costs that they can’t change

Let’s think more specifically about costs

• Fixed Costs = costs that do not change based on production and can not be refunded

• Examples: capital goods, tools, buildings, menus

Nokia factory in Finland

Coke factory in Atlanta, Georgia

Special fixed costs

• “Entry costs” – costs to start up the business

Business with lowEntry costs

Business with very highEntry costs

Costs we can change in the short run

Variable costs = costs that change based on production

The more I produce, the more cost I will incur.

If I don’t produce at all, my variable costs will be 0

For example: labor, electricity, raw materials

Nike factory in China

Michael Jordan visiting Nike Factory in 1999 Why produce in China?

Marginal Costs

• Marginal costs = the cost of producing 1 additional unit

• For example:

• Why helpful?• Diminishing

marginal product!

Widgets

01234

FC

11111

VC

06

111622

MC

X

Total Costs

• Total Costs = fixed + variable costsFor example:

Widgets

01234

FC

11111

VC

01235

TC

12346

MC

X1112

Revenue

02468

Assume Widgets price

$2/eachProfit

-10122

Averages

• Do you guys bring up or down the GPA of all of Pueblo high school?

• Does the track and field team bring up or down the average weight of Pueblo High School?

• Does a high average cost of living mean that everyone spends a lot to live in California?

Average Costs• Average Fixed Costs = FC/Q

• Average Variable Costs = VC/Q

• ATC = TC/Q

Group assignment1

2

Groups page 276

Problem #4Problem #6