EXAM TWO REVIEW:
A. Explicit Cost vs. Implicit Cost and Accounting Costs vs. Economic Costs:
Economic Cost: the monetary value of all inputs used in a particular activity or enterprise over a
given period.
Æ Economic costs reflect the opportunity cost of resources.
Explicit Costs: paid directly in money - money costs. A firm incurs explicit costs when it pays for a factor
of production at the same time it uses it.
• Explicit Cost = payments by a firm to purchase the service of productive resources (wages, interest,
rent, capital)
Implicit Costs: measured in units of money, but are not paid for directly in money. The costs of
nonpurchased inputs, to which a cash value must be imputed because the inputs are not purchased in a
market transaction. A firm incurs implicit costs when it uses capital, inventories or owner’s resources.
• Implicit Costs = opportunity costs associated with a firm’s use of resources that it owns (wages
foregone by owner, interest rates loss through purchases)
Accounting Costs: Measures the explicit costs of operating a business - RESULTS FROM PURCHASES
OF INPUT SERVICES.
Economic Profit: the difference between the total revenue and the cost of all inputs used by a firm over a
given period. It is the TR - OC. OC are the explicit and implicit costs of the best alternative actions
forgone. (TR-TC)
Æ From now on, if I refer to “profit” that is referring to economic profit.
B. Production and Costs:
COST CURVES:
• Fixed Costs (TFC) = costs that do not vary with output (present even when output, q, = 0)
• Variable Costs (TVC) = costs that vary with the rate of output
• Total costs (TC) = TFC + TVC
• Average Variable Cost (AVC) = total variable cost/ number of units produced
• Average Fixed Cost (AFC) = fixed costs/ output (units produced)
• Average Total Cost (ATC) = total cost (variable and fixed) / number of units produced
• Marginal Cost (MC) = the change in total cost required to produce an additional unit of output.
• Explicit Cost = payments by a firm to purchase the serviced of productive resources (wages, interest,
rent, capital)
• Implicit Costs = opportunity costs associated with a firm’s use of resources that it owns (wages
foregone by owner, interest rates loss through purchases)
C. Pure Competition:
a. Homogenous product (all making the EXACT same thing)
b. Large numbers Firms
c. Firms are small in size (they cannot affect price)
d. NO barriers to entry
These characteristics are important they allow you to differentiate between types of industry.
The profit maximizing purely competitive firm chooses q where MC=MR=P (demand). To determine if
there is a profit or a loss, you can find the per unit profit, which is found from the quantity line and the
