hello and welcome back to the foundation course in managerial economics uh we completed our
discussion on demand and supply analysis in the previous lectures and today we are going
to introduce the we are going to discuss about costs of production and production uh what
are cost curves we are basically going to define a few uh
technical concepts which we are going to use uh throughout the course later part of the
course and we are going to introduce the concept of cost the concept of production output marginal
product etc and the discussions that we are going to have this week is going to form the
foundation of most of the discussions that we will have about market structures in the
uh consecutive weeks and we are going to see that how producers make their decision in
different kinds of market structure looking at the cost curves looking at the concept
of analysing cost that we are going to do this week how the different producer how the
producers in different types of market structures they use these concepts of cost and production
to decide how much output to produce what price to charge uh etc so uh lets start .
so the concepts that we learn and use here are we are going to talk about something called
economic profit and accounting profit now profit as we know it is anyone if we ask what
profit is it obviously determines the difference between the revenue that we get and the cost
we incur to produce that or generate that revenue
so but yet we are going to see that there is a difference between what we are going
to call economic profit and what we call accounting profit and economic profit is something that
we are going to consider during the entire course so whenever we discuss any market structure
we are going to whenever we say profit we mean economic profit and not accounting profit
then we are going to discuss about production function uh about marginal product because
as we discussed in the very beginning of the course that people make decisions or choices
at the margin so we are going to so this kind of dreams about our uh our uh use of the concept
of marginal in every uh sphere of discussions that we are going to have henceforth and marginal
product is one of them and we are going to see what it is
then we are going to discuss about various types of costs and how they are related to
each other now does cost decision of firm change over time because as we know that a
firm has to make some short run decisions like a a producer or a firm is deciding how
much to produce in the within the say next month and the firm has to make certain long
run choices long run decision say for example a company needs to decide
uh how much where does it see itself in say 2 years time like is it going to produce the
same amount of output that it is producing today or would it like to produce more or
would it like to produce less uh so depending on the market depending on the kind of uh
costs it faces it needs to make these choices so
obviously that means that the cost is not exactly similar in the short run and in the
long run and we are going to discuss what what we mean by that short run cost long run
cost and we are going to discuss about something called economies of scale .
so lets define revenue cost and profit so revenue everyone knows revenue is basically
uh price multiplied by the by the number of units we are able to sell so revenue is basically
price multiplied by q where q is the number of units of output and the price that it fetches
in the market so in the discussion in this weeks discussion
we are not going to talk about p or where p comes from uh p is exogenously given and
we are going to discuss we are going to try to understand that where does q come from
uh what does q look like for a producer he needs to understand uh what is his production
choices would look like and what his costs would look like so we would like to we are
going to talk more about uh this q in this week .
coming back to the slide so profit is total revenue minus total cost and the assumption
that we will be making throughout this lecture is firms objective is to maximize profit so
so not only in this lecture in the entire course we are uh assuming that the firms objective
is to maximize profit there is no harm in assuming that the that
a firms objective is maximizing say revenue or say minimizing cost but for for simplicity
lets assume that uh the firms objective is maximizing profit but that does not mean that
the firm that a firm always maximizes profit it could have some other kinds of objectives
also depending its depending on its long term strategy etc but we are not going to going
into those details in this course its beyond the scope of this course
next we are going to introduce something called explicit cost and implicit cost now explicit
cost is basically defined as direct costs incurred by the producer which he has to pay
for in money terms also known as accounting cost and implicit cost is the value foregone
of resources used which could have been used in other alternatives also known as opportunity
cost so let me uh let me explain with the help
of an example uh now say for example there is a person who owns a small piece of land
and this land if he decides to rent this land out in the market uh probably he will get
say rupees 500 per week . so theres a piece of land and this person
has to decide he has a piece of land and he can get land can fetch him rupees 500 per
week if he rents it out but instead say the person decides that i am going to use this
land to grow mangoes and i am going to sell the mangoes in the market so for example if
he uses this piece of land the amount of mangoes he is able to produce is say uh he is producing
mangoes and he is which fetches the price in the mango price of mango in the market
is say rupees 50 per kg he produces say 30 kgs per week he sells in the market
so what is his revenue he is getting a revenue of rupees 1500 what are his costs what are
his cost the cost that he is incurring for producing the mangoes say for example he has
to purchase seeds in the market some fertilizers some pesticide etc in the market which costs
him say so his cost is rupees 500 per week this is the amount that he has to spend per
week or he has to pay per week to produce this amount of mango or to get so much amount
of revenue in the market so in that case his profit would be total
revenue minus total cost we would think that the profit is 1500 minus 500 is equal to rupees
1000 per week now here what we are missing out is he is could have rented out this land
in the market and would have earned a amount of rupees 500 per week and say for example
now given this situation say for example now the person knows that there is a nearby shop
who are hiring people and this shop is going to pay him rupees 100 per day if he decides
to work over there now assume that he is when he works over there then the amount say he
works and the shop is open for 6 days a week .
so in that case he is able to if he if he works at the shop he is 6 days a week he is
able to earn rupees 100 into 6 per week so is equal to rupees 600 per week so this is
what he is able to earn per per week now what so in this calculation if we say that his
profit is rupees 1000 per week and this is what is called the accounting profit i am
just coming to that before let me explain about the implicit and explicit cost
now if we calculate this the profit as i have done here then what we are leaving out is
what is the opportunity that he is missing what is the opportunity that he is missing
by growing mangoes what he is missing is he could have rented out the land and earned
a amount of rupees 500 per week he could have worked at the local shop additionally like
additionally he could have rented earned some rent out of here and he could have earned
rupees 600 per week from here these both these earnings he is having to forego because he
has decided to grow mangoes and sell mangoes in the market
so what we say is his cost is his explicit cost is rupees 500 per week but his implicit
cost his implicit cost he is he is having having to incur a implicit cost also so his
implicit cost is equal to rupees 600 plus rupees 500 per week is equal to rupees 1100
per week so this is my definition of explicit cost or accounting cost which is basically
the cost for which i am having to pay by cash this is something which i have to use some
money to get the product to do my uh to to produce the output but this is the cost for
which i am not having to pay anything but this is something which i am foregoing so
this is the opportunity i am foregoing so this is called the implicit cost or the opportunity
cost . so this is my implicit cost or opportunity
cost so
accordingly i am going to define so accordingly i am going to define something called the
accounting profit is equal to total revenue minus explicit cost
which is equal to 1500 minus 500 is equal to 1000 in this case and i am going to define
something called the economic profit which is equal to total revenue minus not only the
explicit cost but also the implicit cost so this is equal to now 1500 minus 500 minus
1100 which makes my profit actually negative so this is minus 100 so basically this person
is losing 100 rupees by choosing to grow mangoes instead of renting out his land and working
in the nearby shop so this is how we define cost in economics and this is how any producer
to optimize his earning in the market that is maximize his profit this is this is how
he should treat his costs and treat his profits so this is the this is the concept behind
it and so explicit cost is coming back to the slide so the explicit cost is direct costs
incurred by the producer which he has to pay for in money terms also known as accounting
cost and implicit cost is value foregone of resources used which could have been used
in other alternatives also known as opportunity cost
so implicit cost is also known as opportunity cost and opportunity cost is something which
we are again going to use throughout the uh throughout economics its a its a very important
concept in economics and i discussed about this even in the first uh lecture so economic
cost is equal to explicit cost plus implicit cost and accordingly we define economic profit
. so economic profit is equal to total revenue
minus explicit cost minus implicit cost now what happens when economic profit is 0 so
we are going to see that uh later when we discuss about perfect competition etc we are
going to see that uh in the long run all the producers earn a profit which is equal to
0 basically we are going to see that in all our calculation ends up in uh total revenue
being equal to total cost .
so what happens when economic profit now pi is a very common form of uh a common symbol
for uh profit in economics and we are going to use pi for profit in most of our lectures
so economic profit equal to 0 what does this mean does this mean that the firm or the producers
is running a loss no it does not mean it is running a loss because it is also including
the implicit cost in its calculation since its including the implicit cost in the
calculation that means that the firm or the person or the producer is at least earning
the amount that he would have earned had he not pursued this production and had he done
done something else so he is at least earning the amount that he would have earned from
his next best alternative so zero economic profit is a normal accounting
profit so zero economic profit is a normal accounting profit and this is also something
which we are going to use very frequently during our discussion on market structure
so it would really help to remember that zero economic profit does not mean that the producer
is not earning anything or he is running a loss
so that uh ends our discussion of this module where we have introduced the concept of explicit
cost implicit cost we have introduced the concept of economic profit accounting profit
and uh the reason for doing so is in the future lectures we when we discussed about cost curves
always remember that we will be using uh both explicit we are using both explicit and implicit
cost so when when we are basically calculating
the cost of any producer we are assuming its the its inclusive of both the explicit and
implicit cost so we will be talking about economic profit we will be talk talking about
both explicit and implicit cost of the producer and that is how we are going to try to understand
what the production decision of the firm looks like what does the cost curves or what do
the cost structures in the short run in the long run how do they look like uh so ill end
this module thank you