Costs and Production

J. Zachary Klingensmith

6 Costs and Production

6.1 Explicit and implicit costs, and accounting and economic profits

Review Activities

Directions: Are the following costs listed implicit or explicit?

Problems

Problem 6.1.1: In order to start a business, you decide to take money out of your retirement account. In total, you take out $200,000 from an account that was earning 7% per year. During the first year, you spend $85,000 on labor, materials, and rent. During the year, you sell a total of 5,000 units at a price of $18/unit. Assume that keeping the money in the account was your next best alternative. Calculate both the accounting and economic profits.

Answers: $5,000; -$9,000

Problem 6.1.2: Farid decides to quit his job as a baker, where he was earning $45,000 per year, to open his own bakery. He withdraws $100,000 from his savings account to start this new business. The money was earning 3% interest per year. During his first year of running his business, he sells 50,000 pastries which he sold for $4 each. His total labor costs were $52,000, his ingredients cost $30,000, and his rent was $38,000. Assume that Farid’s next best option to running his own bakery is the job that he quit (which also means he would keep the money in his savings account.) Calculate Farid’s accounting profit and economic profit for his first year of business.

Answers: $80,000; $32,000

External Resources

Khan Academy: Economic versus Accounting Profit

6.2 production in the short-run

Review Activities

Problems

Problem 6.2.1: Complete the following table.

Quantity of Labor (L)	Total Product (TP)	Average Product (AP)	Marginal Product (MP)
0	0	XX	XX
1	70
2	120
3	150

Answers: 70, 70; 60, 50; 50, 30

Problem 6.2.2: Complete the following table.

Quantity of Labor (L)	Total Product (TP)	Average Product (AP)	Marginal Product (MP)
0		XX	XX
1			100
2		90
3
4	280	70	40
5		58

Answers: 0; 100, 100; 180, 80; 240, 80, 60; X; 290, 10

Problem 6.2.3: Complete the following table.

Quantity of Labor (L)	Total Product (TP)	Average Product (AP)	Marginal Product (MP)
0		XX	XX
1			50
2	90
3			20
4
5	125		5
6		20

Answers: 0; 50, 50; 45, 40; 110, 36.67; 120, 30, 10; 25; 60, -5

External Resources

Khan Academy: Production Functions

Khan Academy: Total Product, Marginal Product, and Average Product

6.3 costs in the short-run

Review Activities

Directions: Attempt to identify each curve. Once you do, click on the (+) to bring up the answer. Pay particular attention to the labeling on the horizontal axis. The vertical axes have not been labeled on purpose.