2. The Meaning of the Cost
• A firm’s cost of production includes all the
opportunity costs of making its output of goods and
services
• Economic Cost or Opportunity Cost
– Forgoing the opportunity to produce alternative
goods and services.
• Explicit Cost
– Accounting cost or money outlay.
• Implicit Cost
– Cost measured by the value of alternative given
up.
3. Economic Profit versus Accounting Profit
• Your Economists measure a firm’s economic profit as
total revenue minus total cost, including both
explicit and implicit costs.
• Accountants measure the accounting profit as the
firm’s total revenue minus only the firm’s explicit
costs.
• When total revenue exceeds both explicit and implicit
costs, the firm earns economic profit.
– Economic profit is smaller than accounting profit
4. Opportunity Cost and Normal Profit
• Normal Profit
– Opportunity cost of capital and enterprise.
– This is the level of profit that is necessary for a firm to remain
in a competitive industry.
5. The Use of Accounting Profits and
Economic Analysis
Accounting Profit Implicit Cost
(Including Normal
Profit)
Accounting Costs =
Explicit Costs
Accounting Costs =
Explicit Costs
Economic Profit
Economic
Cost = Implicit
Cost +
Accounting
Cost
Total
Revenue
6. Cost In The SHORT TERM
• Short Term - one year or less, often used to refer
to bonds or loans.
• Long Term - long period of time, as for a bond (10
or more years) or for a buy and hold investment
strategy.
7. Cost Defined
• Total Cost (TC)
– The sum of all the cost of production for a given level of
output.
• Total Fixed Cost (TFC)
– The cost of the fixed factors of production. Total fixed cost
does not vary in the short run.
• Total Variable Cost (TVC)
– Total of cost that vary directly with output, increasing as more
output is produced.
8. Cost Defined
• Average Total Cost (AC)
– Total costs of production divided by the number units of
output.
AC = TC
Q
• Average Fixed Cost (AFC)
– Total fixed costs of production divided by output. Average
fixed costs decline as production is increased.
• Average Variable Cost (AVC)
– Total variable cost divided by the number of units of out put.
9. Cost Defined
• Marginal Cost (MC)
– Change in total cost from producing some more (or less) unit
output.
∆
MC =
