Supply and Production Cost

Supply and Production Cost

Difference between explicit and implicit cost of production

Ans part a) The total cost of production is the cost of all the inputs at their market value that is used in the production of a firm. The sum of fixed and variable cost makes up the total cost. As the name of the fixed cost suggest, the cost does not change with the level of output. However, the variable costs vary or fluctuate in accordance with the activity conducted in the business. The total opportunity cost is made up of Implicit and Explicit costs (Mankiw, 2012).

The explicit cost or the direct cost is the obvious cost which caters to purchase the productive resources. These costs have tangible outflow of cash, directly affecting the profits. Such costs include cost of medical supply, rents, wages and utility bills.

Implicit costs are not easy to quantify or measure. It is the cost to forego the next best alternative for the use of resource that is the opportunity cost. This is often overlooked when the decisions are being made and the result is being analyzed. However, these costs are the actual cost that occur in the firm. The managers can use the internal resources to identify and measure these costs.

The application that determines the difference can be witnessed in accounting profit versus economic profit. The accounting or the bookkeeping takes only explicit cost into consideration in order to determine the profit and loss. However, economic profit considers both, explicit and implicit costs. The company maybe experiencing profit in the accounting books, whereas economic profit will be achieved if the revenue is greater than the explicit and implicit cost, both combined.

U shaped long run average cost curve

Ans part b) The average cost curve is the total cost upon the output (quantity produced). The average cost is evenly dispersed on the number of units produced. The graphical representation of the long run average cost curve is U shaped (Leitner, 2011). Long run average cost is made up of many short run average cost curves. There are some reasons that cause this shape of the graph.

At the initial phase the firm can decrease its cost by increasing the production. As the production increases the cost decreases. The firm is experiencing the increasing return to scale that is when there is an increase in the input, the output increases with a greater extent. It can also be said that the firm is experiencing the economies of scale (Leitner, 2011). This is reflected by the negatively sloped part of the graph. There will come a time when the company undergoes through constant returns to scale. This is when an increase in the input, the output increases with the same rate. The diseconomies of scale cause the greater increase in cost than the outcome. The positive slope of the graph depicts the decreasing return to scale which is the increase in input is less than the increase in ...