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Chapter 21 How Cost
of Production Affects Supply
Telling Teachers about
When
printing these three pages, use portrait at 70% with minimum margins.
these free teaching materials might help lower the cost of
textbooks.
A. The last two chapters were an in-depth exploration of demand.
B. This chapter will explore costs, the key determinate of supply.
C. Math Review is a short dynamic review of basic math skills for microeconomics from R. L. Reynolds of Boise St. University.
D. McConnell Microeconomics Review is one of many source of material included in this chapter.
E. Our Current Events Internet Library has an interesting economics section.
II. Understanding costs
A. Costs are the dollars paid for the factors of production.
B. Opportunity cost is the value of the best alternate use, e.g., the opportunity cost of labor is the value that
could have been received from using capital.
C. Explicit costs versus implicit costs
1. Explicit costs require an out-of-pocket expenditure, e.g., wages, materials, and overhead.
2. Implicit costs do not require an outlay, e.g., forgone interest on invested capital, forgone rent a company could receive by renting a facility used
in the business, forgone wages for uncompensated efforts by family members in a family-operated business, forgone entrepreneurial income you
could earn by managing another business. Included a normal return on investment, which is the minimum amount required to keep resources
employed at their current use.
D. Short run versus long run costs
1. In the short run costs are both fixed and variable.
a. Fixed costs do not vary with production, e.g., plant and equipment, property taxes, most overhead, etc.
b. Variable costs vary directly with production, e.g., labor and materials
c. Marginal cost is the change in total costs which results from making one more unit.
2. In the long run all costs are variable as fixed costs may increase.
E. Diminishing returns:
1. Adding a variable resource (labor) to a fixed resource (capital) will increase production for a while.
2. At some point the rate of increase declines and eventually becomes negative.
3. Diminishing returns affect both the production of labor and cost of production.
4. Example: When eating at my mother's house I would say using three people to do the dishes didn't make sense
because the third person just got in the way. She agreed so me and my sisters did the dishes.
5. Diminishing returns - Wikipedia has additional information.
6. Econ Concepts in 60 Seconds Video on The Law of Diminishing Marginal Returns reviews diminishing returns and previews section III on
labor productivity.
F. Accounting profits versus economic profits
1. Accounting profit is revenue minus explicit costs.
2. Economic profit is revenue minus explicit plus implicit costs.
3 Since implicit cost includes a payment for the risk factor part of interest and payment for entrepreneurial skill.
4. This means
a. Normal Profit is a cost to economists and paid for as an explicit cost.
b. In the long run competition causes economic profit to be zero.
c For another explanation read the beginning of
