Micro: Unit 3.2 -- Production Costs
Summary
TLDRIn this video, Mr. Willis explains key economic concepts related to production costs, including the difference between explicit and implicit costs, and how firms calculate accounting and economic profits. He explores fixed and variable costs, total production costs, and how these influence a firm’s decision-making process. The video also introduces per-unit production costs such as average fixed cost, average variable cost, and marginal cost, while highlighting the impact of diminishing marginal returns. Through practical examples, viewers gain a better understanding of how firms manage costs to maximize profits.
Takeaways
- 💼 Economics distinguishes between explicit costs (out-of-pocket payments) and implicit costs (opportunity costs) of production.
- 🔢 Accountants consider only explicit costs, while economists include both explicit and implicit costs in their calculations.
- 💹 A firm earns accounting profits if revenue exceeds explicit costs, but economic profits require revenue to exceed both explicit and implicit costs.
- 🏭 Fixed costs are constant and include expenses like rent, insurance, and business licenses, which do not change with output level.
- 🔄 Variable costs change with production levels and include wages, electricity, and raw materials.
- 📈 Total cost is calculated as the sum of fixed and variable costs, increasing with output.
- 📊 Average fixed cost per unit decreases as output increases because fixed costs are spread over more units.
- 📉 Average variable cost and average total cost initially decrease due to efficiency but can increase with the law of diminishing returns.
- 📋 Marginal cost is the additional cost of producing one more unit and is calculated by dividing the change in total cost by the change in output.
- 🍽️ The example of a small diner illustrates how to calculate fixed, variable, total, average, and marginal costs, emphasizing the importance of covering these costs through pricing.
- 📈 As production increases, the fixed cost per unit diminishes, but average variable and total costs may rise due to the law of diminishing marginal returns.
Q & A
What are economic costs in the context of production?
-Economic costs include both explicit costs, which are out-of-pocket payments for land, labor, and capital, and implicit costs, which are the opportunity costs of using resources.
How do economists and accountants differ in their view of production costs?
-Accountants only consider explicit costs (out-of-pocket expenses), while economists include both explicit and implicit costs (opportunity costs).
What is the significance of opportunity costs in economic decision-making?
-Opportunity costs represent the value of the next best alternative that is foregone when resources are used in a particular way, which is crucial for economists in analyzing trade-offs.
How do accounting profits differ from economic profits?
-Accounting profits are the difference between revenue and explicit costs, while economic profits subtract both explicit and implicit costs from revenue.
What happens if a firm's revenue exceeds its explicit costs but not its economic costs?
-The firm is earning accounting profits but incurring economic losses, as it cannot cover the total of both explicit and implicit costs.
What are fixed costs in the production process?
-Fixed costs are expenses that do not change with the level of production, such as rents, interest payments, insurance, and business licenses.
How do variable costs change with production levels?
-Variable costs increase with higher production as more resources like labor and equipment are required, and decrease when production levels drop.
How is total cost calculated in the production process?
-Total cost is the sum of fixed costs and variable costs. As production increases, variable costs increase, and so does the total cost.
What is marginal cost, and how is it calculated?
-Marginal cost is the cost of producing an additional unit of output. It is calculated by dividing the change in total cost by the change in total product (output).
Why do average fixed costs decrease as output increases?
-Average fixed costs decrease because fixed costs are spread over a larger number of units as production increases, reducing the cost per unit.
Outlines
💼 Economics of Production Costs
This paragraph introduces the concept of economic costs during the production process, differentiating between explicit costs (out-of-pocket payments for resources like land, labor, and capital) and implicit costs (opportunity costs of using resources). It explains that while accountants only consider explicit costs, economists include both explicit and implicit costs due to the importance of opportunity costs and scarcity. The paragraph also discusses how these costs affect a firm's profits, distinguishing between accounting profits (revenue exceeding explicit costs) and economic profits (revenue exceeding both explicit and implicit costs). It concludes with an introduction to fixed costs, variable costs, and total costs, using the example of starting a small diner to illustrate these concepts.
📈 Calculating Production Costs for a Small Diner
The second paragraph delves into the specifics of calculating production costs for a small diner, starting with fixed costs that remain constant regardless of output level. It explains how variable costs change with output and are calculated by adding the wages and rents of variable resources. The paragraph outlines how to calculate total costs by summing variable and fixed costs. It then introduces the concept of per-unit production costs, including average fixed cost, average variable cost, average total cost, and marginal cost. Each of these costs is calculated using the example of the diner, showing how costs change as output increases. The paragraph emphasizes the importance of understanding these costs for a firm to maximize profits.
📊 Pricing Strategy Based on Production Costs
The final paragraph focuses on how the diner must price its meals to cover production costs. It discusses the relationship between average fixed cost, average variable cost, and average total cost with the quantity of meals produced. The paragraph explains that as production increases, the fixed cost per unit decreases due to the law of diminishing returns. It also highlights how average variable cost and average total cost initially decrease and then increase with production due to the same law. The paragraph uses a hypothetical scenario with workers to illustrate how diminishing returns affect average variable cost. It concludes by encouraging viewers to subscribe to the channel for more economic insights.
Mindmap
Keywords
💡Economic Costs
💡Accounting Profits
💡Economic Profits
💡Fixed Costs
💡Variable Costs
💡Total Cost
💡Average Fixed Cost
💡Average Variable Cost
💡Average Total Cost
💡Marginal Cost
💡Law of Diminishing Marginal Returns
Highlights
Economic costs include both explicit and implicit costs, whereas accountants only consider explicit costs.
Explicit costs are out-of-pocket payments for acquiring resources like land, labor, and capital.
Implicit costs represent the opportunity costs of using resources during the production process.
Accounting profits are earned when revenue exceeds explicit costs, but economic profits require revenue to exceed both explicit and implicit costs.
Firms can earn accounting profits while incurring economic losses if their revenue does not cover both explicit and implicit costs.
Fixed costs are constant and include overhead costs like rent and insurance, regardless of production level.
Variable costs change with output and include wages for labor and rents for equipment.
Total cost is the sum of fixed and variable costs, and it increases with output due to rising variable costs.
Average fixed cost decreases as output increases because fixed costs are spread over more units.
Average variable cost and average total cost initially decrease due to increasing productivity but eventually increase due to the law of diminishing marginal returns.
Marginal cost is the cost of producing one additional unit and is calculated by dividing the change in total cost by the change in output.
Firms need to cover per unit production costs to avoid losses, which includes setting prices that reflect these costs.
The small diner example illustrates the calculation of fixed costs, variable costs, total costs, and per unit costs in a practical scenario.
Average fixed cost per unit is calculated by dividing total fixed costs by the quantity of output.
Average variable cost per unit is found by dividing total variable costs by the quantity of output.
Average total cost per unit is calculated by dividing total costs by the quantity of output or by summing average fixed and variable costs per unit.
Marginal cost helps firms decide the optimal level of production by showing the additional cost of producing one more unit.
The video provides a comprehensive overview of production costs, including fixed, variable, total, and per unit costs, and their implications for pricing and profitability.
Transcripts
hey everyone i'm mr willis and you will
love
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economics
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during the production process firms
accumulate costs as they pay the wages
and rents required
to purchase land labor and capital
in economics all costs are economic
costs
because they account for both the
explicit and implicit costs of acquiring
inputs
the explicit costs of production are the
out-of-pocket cash payments
paid by firms in order to acquire the
land labor and capital needed
to produce economic goods the implicit
costs of production
are the opportunity costs of using
resources during the production process
let's clear something up accountants and
economists
look at costs differently when
calculating costs
accountants only include the explicit or
out-of-pocket costs paid by firms
to use resources during the production
process
on the other hand economists count both
the explicit
and the implicit cost of production
because economists are concerned
with the opportunity costs and
trade-offs due to the problems presented
by scarcity as a result
the difference between accounting costs
and economic costs
is the sum of the opportunity cost of
using resources
during the production process so how
does this factor into profits for the
firm
when a firm sells a good in the product
market the price collected per unit
creates revenue for the firm in
accounting
if the revenue earned by the firm is
greater than the explicit cost of
production
the firm is earning accounting profits
in order for the firm to earn economic
profits however
the revenue earned by the firm must be
greater than the sum
of both the explicit costs and the
implicit cost
of production if the revenue earned by
the firm
is greater than the explicit cost of
production but less than the combined
sum
of explicit and implicit costs the firm
is earning enough revenue
to cover their accounting costs but not
enough to cover their economic costs
this means that they're earning
accounting profits by taking
economic losses at the same time
in economics we cut through the
confusion and make things simple
because all costs are economic costs
any and all costs of production from
here on out
include both explicit and implicit costs
if revenue exceeds economic costs the
firm
is earning economic profits if
economic costs exceed revenue the firm
is taking economic losses and
if revenue equals economic costs the
firm
is breaking even when producing
output firms face several different
types of production costs
fixed costs are the wages and rents of
the fixed resources
used during the production process these
costs do not change with the amount of
output produced
and they can include rents on land
interest payments on loans
as well as insurance and business
licensing
fixed costs are often referred to as
overhead costs
because they must be paid regardless of
production level
and sometimes even before production
begins
variable costs are the wages and rents
of variable resources used during the
production process
these costs do change with the amount of
output produced
when the firm produces more output it
faces
higher variable costs when the firm
produces
less output it faces lower variable
costs
variable costs include hourly wages paid
to workers
as well as rents paid for electricity
capital equipment
and raw materials total cost is the sum
of the variable costs
and the fixed cost of production the
more output produced
the higher total costs are to firms
because variable costs increase
as production increases the less output
produced
the lower total costs are to the firm
because variable costs
decrease as production decreases let's
practice
suppose an entrepreneur sets out to
start a small diner in your hometown
to get started the business owner is
going to have to pay overhead costs on
several fixed resources
before opening his doors or even
producing a single plate of food
he has to pay rent on his store purchase
fire insurance
and pay for several required business
licenses
these overhead costs add up to 100 in
fixed costs for the firm
before the doors have even opened or
production has even begun
because fixed costs remain constant and
do not change with the quantity of
output produced
the firm will face this 100 fixed cost
of production
no matter how much food they produce
now in order to begin production the
store owner has to combine several
variable inputs
including labor electricity
refrigerators
cooktops and other equipment when
combining the wages and rents
of the labor and capital required to
produce the first 10 plates of food
the store owner will face a variable
cost of 80
however as output increases
the owner will have to hire more workers
and rent more equipment
meaning that the variable cost of
production will increase
as production increases from here
we can calculate the total cost of
production for the diner
by adding the fixed cost of production
to the variable cost
of production at every output level
notice that fixed costs remain constant
at every output level
while variable costs and total cost
increase
as output increases also notice
that the difference between the total
cost and variable cost of production at
each
output level is the sum of fixed
production costs for the firm
because firms are seeking to maximize
profits it is important for firms to
gauge
the fixed variable and total costs
attributed
to each unit that they produce these per
unit production costs
help ferbs decide the total quantity of
output they should produce
as well as the profit earned or loss is
taken
per unit of output there are four
different types of per unit production
costs
average fixed cost average variable cost
average total cost and marginal cost
average fixed cost tells the firm the
fixed cost of production
per unit of output produced to calculate
the average fixed cost per unit
we simply need to take the fixed cost of
production and divide it
by total product average variable cost
tells the firm
the variable cost of production per unit
of output produced
to calculate the average variable cost
per unit we simply need to take
the variable cost of production and
divide it by total
product average total cost tells the
firm
the combined cost of both fixed and
variable resources
per unit of output produced in other
words
it tells the firm the total cost of
production per unit
of output to calculate the average total
cost per unit
we simply need to take the total cost of
production and divide it
by total product marginal cost is the
cost of producing each additional unit
of output
in other words by how much will total
cost increase
with the production of each additional
unit of a good or service
to calculate the marginal cost of each
unit of output
we simply need to take the change in
total cost and divide it
by the change in total product
let's take a closer look at calculating
per unit production costs
let's go back to that small diner in
your hometown
here we can see the production cost that
we calculated earlier
we can use the fixed cost variable cost
and total cost of production at
each level of output to calculate the
per unit production costs for the firm
let's start with the average fixed cost
we can divide fixed cost
by the total product at each output
level to find the average fixed cost per
unit
next let's calculate average variable
cost
we can divide variable cost by the total
product at each output level
to find the average variable cost per
unit
now let's calculate average total cost
we can divide total cost by the total
product at each output level
to find the average total cost per unit
however because total cost is the sum
of fixed cost and variable costs average
total cost can also be found
by adding the average fixed cost per
unit to the average variable cost per
unit
and lastly let's calculate marginal cost
at each output level the diner increases
its total product
by 10 meals as a result
we can divide the change in total cost
at each output level
by 10 meals to find the marginal cost of
producing
each additional meal notice several
things
each of these sums represents the fixed
cost variable cost
and total cost of producing each meal at
every output level
in order to cover these production costs
the diner must sell
each meal at a price that is equal to or
greater than the production cost per
unit
for example when producing 40 meals
the average fixed cost of producing each
meal is
fifty 2.50 in order to generate enough
revenue to cover their fixed production
costs
the diner must sell each meal at a price
of two dollars and fifty cents
or higher when producing sixty meals
the average variable cost of producing
each meal is five dollars
in order to generate enough revenue to
cover their variable production costs
the diner must sell each meal at a price
of five dollars or higher
when producing 50 meals the average
total cost of producing each meal
is six dollars and 80 cents
in order to generate enough revenue to
cover their total production costs
the diner must sell each meal at a price
of six dollars and 80 cents
or higher also
notice that the fixed cost per unit gets
smaller as total product increases
this is because as production increases
fixed production
costs which remain constant are divided
among
more and more units of output and
lastly notice that the average variable
cost
and the average total cost initially
decrease and then
increase as total product rises
this is due to the law of diminishing
marginal returns
initially variable resources are more
productive for the firm
meaning each unit of output they produce
has a lower variable cost
then as diminishing return sets in
each additional variable resource is
less productive than the last
causing the variable cost per unit of
output to increase again let's put it
this way
suppose the diner hires three workers
and the only variable cost
is the hourly wage of ten dollars paid
to each worker
if the first worker can produce ten
meals each meal has an average
variable cost of one dollar
if the second worker can produce 15
meals each meal now has an average
variable cost
of 80 cents however
if diminishing return sets in and the
third worker has a marginal product of
only five meals the average variable
cost of
each meal would increase again to one
dollar
because average total cost is the sum of
average fixed cost and average variable
cost
average total cost parallels average
variable cost
and the total cost per meal produced by
the diner initially decreases
and then increases because of
diminishing returns
and that's production costs be sure to
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