Principles of Economics II (Microeconomics)

Organizing Production

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Overview

1. Review

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2. Course Objectives

Write out the fourth, fifth, and sixth course objectives from text page 196:

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3. Outline

A. A firm’s opportunity cost of producing a good is the best alternative action the firm foregoes to produce it. Although often measured in dollars, the opportunity cost is the best foregone alternative.

B. Opportunity cost can be divided into explicit and implicit costs. Explicit costs are paid directly with money. Implicit costs are not paid directly but are incurred whenever a firm uses its capital, its inventories, or its owners’ time.

1. The (implicit) cost of using capital is its economic depreciation — the change in the capital’s market value — plus any interest either paid or foregone as a result of acquiring the capital.

a) The implicit rental rate, or what a firm "pays" to itself to rent its equipment, is a measure of the opportunity cost of capital equipment.

b) A sunk cost is a cost that has been incurred and cannot be reversed; sunk cost is not an opportunity cost of currently using capital.

c) Accountants use a fixed depreciation rate to measure depreciation, rather than attempt to measure economic depreciation.

2. Inventories are stores of raw materials, semifinished goods, and finished goods held by firms. The opportunity cost of an item used from an inventory is its current replacement cost.

a) Accountants often use FIFO (first in, first out) or LIFO (last in, first out) historical cost accounting methods to measure the cost of using an item from inventory.

3. The opportunity cost of the owner’s time, which often is income foregone by not working at the best alternative job, is a cost to the firm.

a) Owners also often supply entrepreneurial ability to help run the company. The expected return from this contribution is called the normal profit. A firm’s normal profit is part of its opportunity costs.

C. Economic profit equals total revenue minus all opportunity costs of production.

1. A normal profit is already part of the firm’s opportunity costs, so an economic profit is a profit over and above the normal profit.

2. Because opportunity costs generally are greater than the accountant’s measure of costs, economic profit usually is less than profit as measured by an accountant.

A. Technological efficiency occurs when increasing output without increasing inputs is impossible.

1. Technological efficiency depends only on engineering considerations.

B. Economic efficiency occurs when the cost of producing a given level of output is as low as possible.

1. An economically efficient production process also is technologically efficient; however, a technologically efficient process may not be economically efficient.

A. Firms and markets both coordinate resources.

B. Firms coordinate resources when they can do so more efficiently than a market. Firms sometimes can be more efficient than markets for four reasons:

1. Firms may reduce transactions costs, which are the costs arising from finding someone with whom to do business, negotiating transactions, and ensuring that the transactions occur as agreed upon.

2. Firms may better capture economies of scale, whereby the cost of producing a unit falls as more of the product is produced.

3. Firms can capture economies of scope, whereby one firm can used specialized inputs to produce many different goods at lower cost than otherwise.

4. Firms can engage in team production, in which individuals work as a group with each person specialized in a particular task.

4. PowerPoint Viewgraphs  (Slides 20 - 28, 29 - 48, and 49 - 54)

Notes