Economics Lecture: Production Costs and Profits

Introduction to Economic Costs

• Economic Costs: Include both explicit and implicit costs.
  • Explicit Costs: Out-of-pocket expenses (e.g., wages, rents).
  • Implicit Costs: Opportunity costs of using resources.
• Accounting vs Economic Costs:
  • Accountants consider only explicit costs.
  • Economists consider both explicit and implicit costs.

Understanding Profits

• Accounting Profits: Revenue > Explicit Costs.
• Economic Profits: Revenue > (Explicit Costs + Implicit Costs).
• A firm might have accounting profits but economic losses when implicit costs aren't met.

Production Costs

• Fixed Costs: Costs that do not change with the level of output.
  • Includes rents, interest payments, insurance, and licenses.
  • Also known as overhead costs.
• Variable Costs: Costs that change with the level of output.
  • Includes wages, electricity, equipment rentals, raw materials.
• Total Costs: Sum of Fixed Costs and Variable Costs.

Practical Example: Small Diner

• Fixed Costs: $100 for rent, insurance, licenses.
• Variable Costs: $80 for producing first 10 plates, increases as production increases.
• Total Cost Calculation: Sum of Fixed and Variable Costs.

Per Unit Production Costs

• Average Fixed Cost (AFC): Fixed Cost / Total Product.
• Average Variable Cost (AVC): Variable Cost / Total Product.
• Average Total Cost (ATC): Total Cost / Total Product = AFC + AVC.
• Marginal Cost (MC): Change in Total Cost / Change in Total Product.

Calculating Example for Diner

• Example Calculations:
  • AFC decreases as more units are produced due to fixed costs spread over more units.
  • AVC and ATC initially decrease, then increase due to diminishing marginal returns.
• Pricing Strategy:
  • Price per meal should cover the production costs (e.g., AFC, AVC, ATC).
  • Example: To cover ATC of $6.80, price should be at least $6.80 per meal.

Law of Diminishing Marginal Returns

• Concept: Initially, adding variable resources increases productivity, lowering AVC.
• Impact: Eventually, adding more resources lowers productivity, increasing AVC and ATC.

Conclusion

• Understanding costs and pricing is crucial for maximizing profits.
• Firms should analyze fixed, variable, and total costs when planning production.

Additional Resources

• Subscriptions and alerts for new videos on economics topics.
• Video lectures available on various macro and microeconomic topics.