Micro: Unit 3.2 -- Production Costs

Summary

In 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.