Total Production Cost
- Total production costs are the sum of implicit and explicit (Economic Costs). Economic costs includes fixed and variable costs of producing a given product (Accounting Costs) plus the opportunity cost of producing each unit of output. Variable costs include inputs such as labor and raw materials. Fixed costs are those that do not vary in a short period of time. For example, the cost of production for one unit cannot easily determined for a building or a machine. Therefore, a building and a machine would be included in fixed costs. Opportunity costs are the implicit costs.
Explicit Costs
- Accounting costs are those that require an outlay of money (explicit costs). Some examples of explicit costs are wages paid to employees, cost of materials, and utility payments.
Implicit Costs
- In the economic method, the opportunity costs (implicit) of production are taken into account. Implicit costs are those "of resources the firm’s owner makes available for production with no direct cash outlays." Some examples include value of labor and interest that could be earned if the less money was tied up in assets of the firm.
Example of Explicit and Implicit Costs:
Suppose you choose to leave a job that is paying you $50,000 per year to open a bar. After a year of operation, you determine the bar generates approximately $200,000 while costs are approximately $70,000. The costs include purchasing food, alcohol, and employee wages. The $70,000 is your explicit costs because those costs require direct payments for purchase. The $50,000 per year that you gave up to start the bar are the opportunity costs.
Average Costs - Average costs can be broken down into short run and long run average costs. Multiple short run costs help to determine long run average costs.
Long Run Average Costs (LRAC)
- The long-run cost curves are expressed in their average or per unit form. The LRAC is created by joining parts of the SRAC curves.
Short Run Average Costs (SRAC)
- The short-run cost curves are enveloped by the long-run cost curve.
The long-run average cost (LRAC) curve is an envelope curve of the short-run average cost (SRAC) curves. Increasing, constant and decreasing returns to scale are exhibited at points a, b and c, respectively.
Average Variable Cost
- Average variable cost is calculated by dividing total variable cost by the output. A AVC curve forms a U-Shape. The AVC will interest the marginal cost curve at the AVC's minimum. Where marginal cost is below AVC, AVC is falling. When marginal cost is above AVC, AVC is rising (Arnold). Average total cost (ATC) equals the sum of the average fixed costs and the average variable costs.
Marginal Cost -Marginal costs (MC) show how much the total costs will change in the production level by one unit. Marginal costs will be equal to zero if there are only fixed costs. Any increase in production will not increase costs with only fixed costs present. On the other hand, marginal costs will be equal to variable costs if only variable costs are present. MC is calculated by dividing the change is cost from the additional unit of output by the change in quantity from the additional unit of output (=∆TC /∆Q).
The graph below shows how each curve is affected by increases/decreases in price and/or quantity.
To illustrate how quantity, fixed costs, variable costs, total costs, and marginal costs all effect each other, here is a small scenario from the bar the you chose to create after quitting your other job (see implicit and explicit costs example).
Scenario: Friday night is your big night at the bar and you wish to figure out the marginal cost for producing cheeseburgers for your customers. For this, chose different quantity levels of output. This scenario will use quantities of 100, 200, 300, and 400. Your fixed costs are $1800. Your variable costs are $4.00/cheeseburger. From this information, the total cost and marginal cost for each level of output can be calculated. See table below for calculations.
Sunk Cost -Sunk costs cannot be recovered from the sale of an asset produced because the costs occurred before the activity. They are essentially fixed costs that cannot be regained. They are irrelevant in decision making because once incurred, there is no way to recover those costs. A manager must make sure to ignore all sunk costs in decision making to maximize any gain from sale. An example of a sunk cost would be research and development. Once the research and development is complete, there is no way to recover those particular costs.
Example: You've been funding a new product effort for your company. You spent approximately $500,000 to cover the costs of product developers, a manager, and other team members. All $500,000 are sunk because you already spent that money and there is no way to get that money back.
Quiz Questions
1) Suppose you purchased a car for $20,000 in 2005. You just wrecked that car and the local body shop is estimating the car will cost approximately $7,000 to repair. Alternatively, you could choose to sell the car for $3,000. What would your total sunk cost be?
a. $7,000
b. $20,000
c. $23,000
d. $10,000
*Answer: B - The $20,000 has already been incurred and there is no way to recover this amount, therefore, it is a sunk cost.
2) A payment to your utility company was made. Which type of cost is this?
a. Explicit Cost
b. Implicit Cost
c. Variable Cost
d. Sunk Cost
*Answer: A - It is an explicit cost because a direct monetary payment was made.
3) Suppose a recording studio produces 500 CD's. The total cost was $2,000 and the total fixed cost were $750. At a quantity of 500 CD's, what is the average variable cost?
a. $2
b. $4
c. $1.50
d. $2.50
*Answer: D - Total variable cost is equal to total cost ($2,000) less fixed cost ($750) which equals $1,250. Total variable cost is divided by the number of CD's produced (500). Average variable cost is $1,250/500 units, which equals $2.50 per unit.
4) Which cost curve only contains variable factors of production?
a. Long run average cost curve
b. Short run average cost curve
c. Total fixed cost curve
d. Total cost curve
*Answer: A - Long run average cost curves do not contain any fixed costs.
5) Suppose you quit your job that is paying you $40,000 per year to work part-time at the local pharmacy. The job at the pharmacy pays you $30,000 and allows you to spend more time with your family because it is only part-time work. What is your opportunity cost of taking the job at the pharmacy?
a. $30,000
b. $10,000
c. $40,000
d. $0
*Answer: C - You are choosing to give up $40,000 per year from your old job. Therefore, this is your opportunity cost.
References:
Arnold, R. A. (2008). Economics, 8th Edition. San Marcos: Thompson Learning Inc..
Baye, Michael. R. (2009). Managerial Economics and Business Strategy, 6th Edition. St. Louis: McGraw-Hill Irwin.
Das, S. P. (2007). Microeconomics for Business. Thousand Oaks: Sage Publications
Koch, Charles. G. (2007). The Science of Success. Hoboken: John Wiley & Sons, Inc.
Tucker, I. B. (2008). Survey of Economics. Mason: South-Western CENGAGE Learning.
The Wiki identifies exactly what a monopoly is and explains four sources that create monopoly power. Legislation was created to help prevent monopolies from occurring. The Wiki then goes into detail about potential for a monopoly as well as a current monopolistic situation. This Wiki is very insightful and provides excellent information on monopolies.
Summary 2 – Auctions including English auction, First price sealed bid auction, second price sealed bid auction, Dutch auction, winners
This Wiki defines all four types of auctions and how each auctions works. It then goes into detail about what types of auctions are typically used in various situations. The information in this Wiki is helpful because it helps one to determine which type(s) of strategy should be used for a given type of auction. Overall, this a very well-written Wiki that contains very useful information.
Summary 3 – Input markets – supply and demand for labor including Marginal revenue product. Input procurement
This Wiki breaks down and defines the different segments of supply and demand for labor. It also discusses how input procurement, spot exchange, contract, and vertical integration relate to input markets. This Wiki provides short but concise examples of various input markets. The charts and graphs in this Wiki help to further define and explain the relationships of each segment.
Summary 4 – Monopolistic Competition
This Wiki explains that monopolistic competition is essentially a mix of perfect competition and a monopoly. It describes both perfect competition and monopoly individually then explains how monopolistic competition combines them. The Wiki also goes into detail about characteristics of monopolistic competition (free entry, product differentiation, many buyers and sellers, limited pricing power, and downward sloping demand curve). This Wiki provides excellent information on how perfect competition and monopoly are very different but can also be combined together.
Summary 5 – Risk – mean, variance, standard deviation, risk averse, risk neutral, risk lover, and optimal search
This Wiki explains how to calculate risk by using mean, variance, and standard deviation. It also gives a good example of how to do these calculations. Based on the calculated risk, it can be determined if the risk is a risk aversion, risk neutral, or risk lover. The Wiki also describes optimal search as finding the optimal path of producing the best product by searching for it. This Wiki packs a lot of useful information into one concise paper.
- Total production costs are the sum of implicit and explicit (Economic Costs). Economic costs includes fixed and variable costs of producing a given product (Accounting Costs) plus the opportunity cost of producing each unit of output. Variable costs include inputs such as labor and raw materials. Fixed costs are those that do not vary in a short period of time. For example, the cost of production for one unit cannot easily determined for a building or a machine. Therefore, a building and a machine would be included in fixed costs. Opportunity costs are the implicit costs.
Explicit Costs
- Accounting costs are those that require an outlay of money (explicit costs). Some examples of explicit costs are wages paid to employees, cost of materials, and utility payments.
Implicit Costs
- In the economic method, the opportunity costs (implicit) of production are taken into account. Implicit costs are those "of resources the firm’s owner makes available for production with no direct cash outlays." Some examples include value of labor and interest that could be earned if the less money was tied up in assets of the firm.
Example of Explicit and Implicit Costs:
Suppose you choose to leave a job that is paying you $50,000 per year to open a bar. After a year of operation, you determine the bar generates approximately $200,000 while costs are approximately $70,000. The costs include purchasing food, alcohol, and employee wages. The $70,000 is your explicit costs because those costs require direct payments for purchase. The $50,000 per year that you gave up to start the bar are the opportunity costs.
Average Costs
- Average costs can be broken down into short run and long run average costs. Multiple short run costs help to determine long run average costs.
Long Run Average Costs (LRAC)
- The long-run cost curves are expressed in their average or per unit form. The LRAC is created by joining parts of the SRAC curves.
Short Run Average Costs (SRAC)
- The short-run cost curves are enveloped by the long-run cost curve.
Average Variable Cost
- Average variable cost is calculated by dividing total variable cost by the output. A AVC curve forms a U-Shape. The AVC will interest the marginal cost curve at the AVC's minimum. Where marginal cost is below AVC, AVC is falling. When marginal cost is above AVC, AVC is rising (Arnold). Average total cost (ATC) equals the sum of the average fixed costs and the average variable costs.
Marginal Cost
-Marginal costs (MC) show how much the total costs will change in the production level by one unit. Marginal costs will be equal to zero if there are only fixed costs. Any increase in production will not increase costs with only fixed costs present. On the other hand, marginal costs will be equal to variable costs if only variable costs are present. MC is calculated by dividing the change is cost from the additional unit of output by the change in quantity from the additional unit of output (=∆TC /∆Q).
The graph below shows how each curve is affected by increases/decreases in price and/or quantity.
Scenario: Friday night is your big night at the bar and you wish to figure out the marginal cost for producing cheeseburgers for your customers. For this, chose different quantity levels of output. This scenario will use quantities of 100, 200, 300, and 400. Your fixed costs are $1800. Your variable costs are $4.00/cheeseburger. From this information, the total cost and marginal cost for each level of output can be calculated. See table below for calculations.
Sunk Cost
-Sunk costs cannot be recovered from the sale of an asset produced because the costs occurred before the activity. They are essentially fixed costs that cannot be regained. They are irrelevant in decision making because once incurred, there is no way to recover those costs. A manager must make sure to ignore all sunk costs in decision making to maximize any gain from sale. An example of a sunk cost would be research and development. Once the research and development is complete, there is no way to recover those particular costs.
Example: You've been funding a new product effort for your company. You spent approximately $500,000 to cover the costs of product developers, a manager, and other team members. All $500,000 are sunk because you already spent that money and there is no way to get that money back.
Quiz Questions
1) Suppose you purchased a car for $20,000 in 2005. You just wrecked that car and the local body shop is estimating the car will cost approximately $7,000 to repair. Alternatively, you could choose to sell the car for $3,000. What would your total sunk cost be?
a. $7,000
b. $20,000
c. $23,000
d. $10,000
*Answer: B - The $20,000 has already been incurred and there is no way to recover this amount, therefore, it is a sunk cost.
2) A payment to your utility company was made. Which type of cost is this?
a. Explicit Cost
b. Implicit Cost
c. Variable Cost
d. Sunk Cost
*Answer: A - It is an explicit cost because a direct monetary payment was made.
3) Suppose a recording studio produces 500 CD's. The total cost was $2,000 and the total fixed cost were $750. At a quantity of 500 CD's, what is the average variable cost?
a. $2
b. $4
c. $1.50
d. $2.50
*Answer: D - Total variable cost is equal to total cost ($2,000) less fixed cost ($750) which equals $1,250. Total variable cost is divided by the number of CD's produced (500). Average variable cost is $1,250/500 units, which equals $2.50 per unit.
4) Which cost curve only contains variable factors of production?
a. Long run average cost curve
b. Short run average cost curve
c. Total fixed cost curve
d. Total cost curve
*Answer: A - Long run average cost curves do not contain any fixed costs.
5) Suppose you quit your job that is paying you $40,000 per year to work part-time at the local pharmacy. The job at the pharmacy pays you $30,000 and allows you to spend more time with your family because it is only part-time work. What is your opportunity cost of taking the job at the pharmacy?
a. $30,000
b. $10,000
c. $40,000
d. $0
*Answer: C - You are choosing to give up $40,000 per year from your old job. Therefore, this is your opportunity cost.
References:
Arnold, R. A. (2008). Economics, 8th Edition. San Marcos: Thompson Learning Inc..
Baye, Michael. R. (2009). Managerial Economics and Business Strategy, 6th Edition. St. Louis: McGraw-Hill Irwin.
Das, S. P. (2007). Microeconomics for Business. Thousand Oaks: Sage Publications
Koch, Charles. G. (2007). The Science of Success. Hoboken: John Wiley & Sons, Inc.
Tucker, I. B. (2008). Survey of Economics. Mason: South-Western CENGAGE Learning.
http://www.economicswebinstitute.org/glossary/costs.htm#marg
http://www.unc.edu/depts/econ/byrns_web/Economicae/Essays/Profit.htm
http://home.manhattan.edu/~fiona.maclachlan/costcurves.pdf
http://www.avc.com/a_vc/2010/07/sunk-costs.html
- Ryan Hartke
SUMMARIES
Summary 1 – Monopoly
The Wiki identifies exactly what a monopoly is and explains four sources that create monopoly power. Legislation was created to help prevent monopolies from occurring. The Wiki then goes into detail about potential for a monopoly as well as a current monopolistic situation. This Wiki is very insightful and provides excellent information on monopolies.
Summary 2 – Auctions including English auction, First price sealed bid auction, second price sealed bid auction, Dutch auction, winners
This Wiki defines all four types of auctions and how each auctions works. It then goes into detail about what types of auctions are typically used in various situations. The information in this Wiki is helpful because it helps one to determine which type(s) of strategy should be used for a given type of auction. Overall, this a very well-written Wiki that contains very useful information.
Summary 3 – Input markets – supply and demand for labor including Marginal revenue product. Input procurement
This Wiki breaks down and defines the different segments of supply and demand for labor. It also discusses how input procurement, spot exchange, contract, and vertical integration relate to input markets. This Wiki provides short but concise examples of various input markets. The charts and graphs in this Wiki help to further define and explain the relationships of each segment.
Summary 4 – Monopolistic Competition
This Wiki explains that monopolistic competition is essentially a mix of perfect competition and a monopoly. It describes both perfect competition and monopoly individually then explains how monopolistic competition combines them. The Wiki also goes into detail about characteristics of monopolistic competition (free entry, product differentiation, many buyers and sellers, limited pricing power, and downward sloping demand curve). This Wiki provides excellent information on how perfect competition and monopoly are very different but can also be combined together.
Summary 5 – Risk – mean, variance, standard deviation, risk averse, risk neutral, risk lover, and optimal search
This Wiki explains how to calculate risk by using mean, variance, and standard deviation. It also gives a good example of how to do these calculations. Based on the calculated risk, it can be determined if the risk is a risk aversion, risk neutral, or risk lover. The Wiki also describes optimal search as finding the optimal path of producing the best product by searching for it. This Wiki packs a lot of useful information into one concise paper.