Section5 Flashcards
What is Total Revenue?
The amount of money a firm receives for the sale of its output.
Define Total Cost.
The market value of all inputs a firm uses in production.
What is Economic Profit?
= Total Revenue - Total Cost
(includes both explicit & implicit costs).
Explain Opportunity Cost.
Benefit/value of the most valuable alternative forgone.
Example of Opportunity Cost
If Mark buys pizza instead of a drink & hamburger, the opportunity cost is the value of the drink and hamburger.
I mean, I think there exist better examples hahah, but i think this was in the slides
Define Explicit Costs.
Input costs that require a direct outlay of money by the firm.
Define Implicit Costs.
- Input costs that do not require a direct outlay of money.
- Example: owner’s time.
The opportunity cost of capital is an important cost to include in any analysis of
firm performance.
What is Accounting Profit?
Accounting Profit = Total Revenue - Explicit Costs.
Difference between Economic and Accounting Profit
Economists consider implicit costs; accountants do not.
Economists are interested in studying how firms make production and pricing
decisions.
Accountants are interested in keeping track of the money that flows into and
out of the firm.
Fixed vs Variable Costs
- Fixed Costs: Not dependent on output (e.g., rent)
- Variable Costs: Dependent on output (e.g., raw materials)
Total Cost formula (short run)
TC = TFC + TVC
Total Cost = Total Fixed Costs + Total Variable Costs
Marginal Cost (MC) formula
-> Average Costs (short run)
MC = ΔTC / ΔQ
delta = ableitung
linear and non-linear
Linear function (𝑇C= 𝛼 + 𝛽Q): first derivative of the total cost function with respect to output
-> abgeleitet: MC = 𝛽
Log-log function (ln𝑇C= 𝛼 + 𝛽ln𝑄): first derivative of the total cost function with respect to output
-> abgeleitet: MC = 𝛽 = 𝜕𝑇C/𝜕𝑄 * 𝑄/𝑇C = cost elasticity
Economies of Scale
Long-run average total cost falls as output increases.
ES = 𝟏/𝑪ost 𝒆lasticity = 𝟏/(𝝏𝑻C/𝝏𝑸)*(𝑸/𝑻C)
ES>1: economies of scale
ES<1: diseconomies of scale
ES=1: constant returns to scale
Diseconomies of Scale
Long-run average total cost rises as output increases.
Learning Curve
Shows how production costs fall as experience and efficiency increase.
The learning curve shows the extent to which hours of labor needed per unit of output fall as the cumulative output increases.
Investment Decision Process
Involves assessing the Net Present Value (NPV) of future cash flows. -> firm perspective
Investment: production of good or acquisition of a good or an asset that will be used
to produce other goods -> consumer goods such as vegetables and investment goods such as machines
Investments show benefits and costs over a long period of time
Investment analysis can be done by:
Firms
Households (Building a new house, buying a car, go to the university,…)
State (building a new road, a park, a tunnel…)
From the society point of view, all costs and benefits should be considered (external
costs and external benefits)
Does a positive profit (on annual report) imply that all economic cost has been covered?
Profit is accounting
Accounting Profit = Total Revenue – Explicit Cost
Economic profit = costs implicit and explicit
Economic Profit = Total Revenue – Total Cost
Total Cost = Explicit Cost + Implicit Cost
Cost of Production
A firm’s cost of production also includes all the opportunity costs of making its output of goods and services.
A firm’s cost of production includes explicit costs and implicit costs.
Example of an Implicit Cost: the Opportunity Cost of Capital
Example:
Bill uses 100’000$ of his savings to start a firm. This money was in a saving
account paying 5% interest.
Since Bill could have earned 5’000$ per year on his saving, we must include this
opportunity cost (implicit cost) in our analysis.
Note that an accountant would not count this 5000$ as part of the firm’s costs.
If Bill had instead borrowed from a bank 100’000$ with an interest rate of 5%
explicit cost.
Accountant would now count 5000$ in interest paid for the bank loan.
Implicit Environmental Costs From a Society Point of View
From an economic and society point of view:
The cost of production includes explicit costs and implicit costs that also
include all external/social costs (ex: health cost due to pollution).
Accounting Profit: Income Statement and Balance Sheet
The income statement measures the flows into and out of the firm.
The balance sheet measures the stocks of assets and liabilities at the
end of the accounting year.
Accounting
ROE = return on equity
Equity is the shareholder equity = net value of company
net income (group profit) / shareholders equity (equity)
Other Differences Between Economic Costs and Accounting Costs
Depreciation is not based on the actual life of a machine. It is mainly regulated by law.
* In Accounting Costs: Depreciation is treated as an expense on financial statements.
* In Economic Costs: The focus is on the asset’s actual value decline and opportunity cost, which may differ from accounting depreciation.
* Accounting View: The company records $10,000 per year in straight-line depreciation.
* Economic View: If the machinery could have been sold for a better investment or has a different market value depreciation rate, economic cost might differ.
Sunk Costs are part of accounting costs.
– Sunk costs are expenditures that have been made and cannot be recovered.
– Sunk costs will not be considered for future decisions.
– Ex: marketing
Social and environmental costs due to negative externalities (air
pollution, noise,…)
U-Shaped Cost Curves
- In the short run, when factors such as capital are fixed, variable factors tend to show an initial phase of increasing marginal product (a firm is capable of
engaging in specialization) followed by decreasing marginal product. - Marginal cost are decreasing followed by increasing marginal cost.
