Ch. 8 Costs & the Supply of Goods 1""Incentives"and"Cooperation"• Residual"Claimants:"individuals"who"personally"receive"the"excess"of"revenues" over" cost s"o The"have"the"incentive"to"increase"revenues"or"reduce"costs"• There"are"two"ways"to"organize"productive"activity"o 1."Contracting:"using"outside"producers"for"specific"task s"o 2."Team"Production:"where"employees"work"together"under"the"supervision"of"the"owner"(or"owner’s"representative)"• Shirking:"working"at"less"than"the"expected"rate"of" p roductivity,"which"reduces"output"• PrincipleGagent"problem:"the"incentive"program"that"occurs"when"the"purchaser"of"service"lacks"full"information"about"the"circumstances"faced"by"the"seller,"and"therefore,"cannot"know"how"well"the"seller"performs"the"service"o Solve:"align"one’s"incentives"The"3"Types"of"Business"Firms"• 1."Proprietorship:"a"business"firm"owned"by"a"single"individual"o Gets"all"the"profits,"but"accepts"all"the"risk"• 2."Partnership:"a"business"firm"owned"by"two"or"more"individuals"o They"share"the"profits"and"the"risk"o Can"have"as"many"partners"as"you"want"• 3."Corporation:"a"business"firm"owned"by"shareholders"o They"have"the"right"to"the"firm’s"profits,"but"their"liability"is"limited"to"the"amount"of"their"investment""Benefits(Costs(How(Many((There(Are(Business(Revenue(Sole(Proprietorship(All"profits"All"risk"72%"4%""Partnership(Share"risk"Share"profits"9%"13%"Corporation(Liability"is"limited"Taxed"twice"19%"83%"Calculating"Economic"Costs"&"Profits"• 1."Explicit"Costs:"the"payments"a"firm"makes"to"purchase"the"goods"and"services"of"productive"resources"i.e."$50,000"• 2."Implicit"Costs:"the"opportunity"costs"associated"with"the"firm’s"use"of"resources"that"it"owns"o i.e."Foregone"interest:"$20,000"x"10%"="$2,000"you’re"missing"out"on"by"not"putting"that"money"in"the"bank"o "i.e."Foregone"rent:"$10,000"you’re"spending"instead"of"selling"the"space/building"for"more"money"o i.e."Foregone"wages:"$30,000"you"miss"out"on"because"you’re"in"college"• 3."Total"Costs"(TC):"the"costs"(both"explicit"and"implicit)"of"all"of"the"resources"used"by"the"firm"2""o Includes"the"normal"rate"of"return"for"the"firms"equity"capital"o Explicit(+(Implicit(=(TC($50,000"+"$42,000"="$92,000(Economic"vs."Accounting"Profit"• Economic"Profit:"the"difference"between"the"firms"total"revenue"and"its"total"costs"(including"both"explicit"and"implicit"costs)"o Econ(profit(=(TR(–((Explicit(costs(+(Implicit(costs)(i.e."0"="$5M"–"($3M"+"$2M)""Company"is"doing"as"well"now"as"it"would"under"any"other"conditions"(not"failing!)"i.e."G1M"="$5M"–"($3M"+"3M)""Business"not"doing"as"well"as"it"could"(should"make"changes)"• Accounting"Profit:"the"sales"revenue"minus"the"expenses"of"the"firm"(does"not"usually"include"implicit"costs)"o Accounting(profit(=(TR(–(Explicit(costs($2M"="$5M"G"$3M"Normal"Profit"Rate"• Normal"Profit"Rate:"zero"economic"profit,"the"competitive"rate"of"return"on"the"capital"and"labor"of"the"owners"• Zero(economic(profit(does(NOT(mean(the(business(is(failing!(o Going"as"well"as"it"possibly"could"as"it"would"anywhere"else"o Positive"economic"profit"is"rare"(firms"would"jump"in"until"it"goes"back"to"zero)"o Negative"economic"profit"means"that"resources"could"be"used"more"efficiently" Firms"would"leave"until"is"goes"back"to"zero" Losing"potential"money"Short"Run"vs."Long"Run"• Short"run:"a"time"period"so"short"that"firm"is"unable"to"vary"some"of"its"factors"of"production"—"some"things"cannot"change"• Long"run:"a"time"period"long"enough"to"allow"the"firm"to"vary"all"of"its"factors"of"production"—"everything"can"change,"lots"of"variability"Categories"of"Costs"• Total"Fixed"Costs"(TFC):"the"sum"of"the"costs"that"do"not"vary"with"output"o Fixed"costs"will"remain"unchanged"as"output"rises"or"falls"in"the"short"run"o i.e."Insurance"premiums,"property"taxes,"rent,"etc."o Does"not"matter"if"you"are"producing"zero"or"1,000"units,"still"have"to"pay"these"costs"• Average"Fixed"Costs"(AFC):"Total"Fixed"Costs"divided"by"the"number"of"units"produced"o AFC(=(TFC/Q(o Average"fixed"costs"always"declines"with"output"—"the"more"the"costs"are"spread"among"the"units"3""• Total"Variable"Costs"(TVC):"the"sum"of"those"costs"that"change"with"output"o i.e."wages,"raw"materials"• Average"Variable"Costs"(AVC):"total"variable"costs"divided"by"the"number"of"units"produced"o AVC(=(TVC/Q(• One"can"get"Total"Costs"(TC)"by"adding"together"Total"Fixed"Costs"(TFC)"and"Total"Variable"Costs"(TVC)"o TC(=(TFC(+(TVC(• Average"Total"Costs"(ATC):"Total"Costs"divided"by"the"number"of"units"produced"o ATC(=(TC/Q"or(ATC(=(AFC(+(AVC"o The"ATC"curve"is"UGshaped"because"Average"Total"Costs"will"be"high"for"both"an"underGutilized"plant"(AFC"is"high)"and"an"overG"utilized"plant"(MC"is"high)" Will"begin"decreasing"and"increases"again"• Marginal"Costs"(MC):"the"change"in"total"costs"required"to"produce"an"additional"unit"of"output"o To(increase(profits:(one(only(produces(if(the(additional(revenue((marginal(revenue)(from(one(more(unit(is(greater(than(the(marginal(cost(of(that(unit( MR">"MC"="go" MR"<"MC"="stop" On"graph,"intersects"ATC"&"AVC"at"lowest"points"on"curves""Output((Q)(TFC(TVC(TC(AFC(AVC(ATC(MC(0"$60"$0"$60"—"—"—"—"1"$60"$20"$80"$60"$20"$80"$20"2"$60"$30"$90"$30"$15"$45"$10"3"$60"$36"$96"$20"$12"$32"$6"4"$60"$52"$112"$15"$13"$28"$16"5"$60"$70"$130"$12"$14"$26"$18"6"$60"$114"$174"$10"$19"$29"$44"Diminishing"Returns"and"Productions"• Law"of"Diminishing"Returns:"as"more"and"more"units"of"a"variable"resource"are"applied"to"a"fixed"amount"of"other"resources,"output"will"eventually"increase"by"smaller"and"smaller"amounts"o Can"increase"at"some"points,"but"will"eventually"decline"again"• Total"Production"(TP):"the"total"output"of"a"good"at"a"given"rate"of"input"• Marginal"Product"(MP):"the"change"in"total"product"associated"with"each"additional"unit"of"labor"• Average"Product"(AP):"the"total"product"divided"by"the"number"of"variable"units"(labor)"used"to"get"that"total"product"o AP(=(TP(/Q(4""• *"Average"product"increases"as"long"as"marginal"product"is"greater"than"the"average"(opposite"is"also"true)"o i.e."Your"GPA"
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