Managerial Economics: Ch-3-2: Theory of Costs | Summary and Q&A

TL;DR

This lesson discusses the theory of costs, including explicit and implicit costs, sunk costs, fixed costs, variable costs, and the relationship between total cost, average cost, and marginal cost. It also covers long-run and short-run average cost curves and the concept of economies of scale.

Key Insights

• 👨‍💼 Costs are the expenses incurred by a business to obtain resources for production.
• 🇨🇷 Explicit costs are direct monetary expenses, while implicit costs are indirect and non-monetary costs.
• 🇨🇷 Sunk costs are fixed costs that cannot be recovered and should not impact future investment decisions.
• 🇨🇷 Fixed costs remain constant, while variable costs increase with the level of production.
• 🇨🇷 Total cost is the sum of fixed costs and variable costs.
• 🇨🇷 Average cost is total cost divided by quantity, and marginal cost is the change in total cost due to the production of one additional unit.
• ⚖️ Long-run average cost curves show economies of scale, constant returns to scale, and diseconomies of scale.

Transcript

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Questions & Answers

Q: What is the difference between explicit and implicit costs?

Explicit costs are direct monetary expenses, such as wages and rent, while implicit costs are indirect and non-monetary costs, such as opportunity costs or lost earnings from choosing one option over another.

Q: Why do economists consider implicit costs, while accountants only consider explicit costs?

Economists consider implicit costs because they provide a more comprehensive view of the resources used by a business. Accountants focus on explicit costs because they are easily measurable and recorded in financial statements.

Q: What is the difference between accounting profit and economic profit?

Accounting profit only considers explicit costs, while economic profit takes into account both explicit and implicit costs. Accounting profit is therefore generally higher than economic profit.

Q: Why should sunk costs not be considered when making investment decisions?

Sunk costs are costs that have already been incurred and cannot be recovered. They are irrelevant to future decision-making because they cannot be changed or recovered. Only the potential costs and benefits going forward should be considered.

Q: How do fixed costs differ from variable costs?

Fixed costs do not change with the level of production and include expenses like rent and salaries. Variable costs, on the other hand, increase as the level of production increases and include costs like raw materials and labor.

Q: What is the relationship between average cost, marginal cost, and total cost?

Average cost is the total cost divided by quantity, while marginal cost is the change in total cost due to the production of one additional unit. Total cost is the sum of fixed costs and variable costs.

Q: What do economies of scale, constant returns to scale, and diseconomies of scale refer to?

Economies of scale occur when average cost decreases as output increases, constant returns to scale occur when average cost remains constant, and diseconomies of scale occur when average cost increases as output increases.

Q: How can the learning curve effect impact per worker productivity and costs?

The learning curve effect refers to the increase in per worker productivity and decrease in per worker costs that occur as employees gain experience and skills. This can be achieved through training, adopting new production systems, and other methods.

Summary & Key Takeaways

• Cost is defined as the expenses faced by a business to obtain the necessary resources for production.

• Costs can be categorized into explicit costs (direct monetary expenses) and implicit costs (indirect and non-monetary costs).

• Sunk costs are fixed costs that cannot be recovered and should not be considered when making future investment decisions.

• Fixed costs remain constant regardless of the level of production, while variable costs increase with output.

• Total cost is the sum of fixed costs and variable costs.

• Average cost is total cost divided by quantity, and marginal cost is the change in total cost due to the production of one additional unit.

• Long-run average cost curves show economies of scale, constant returns to scale, and diseconomies of scale.