Marginal Analysis Flashcards
What is the accounting concept cost?
The accounting concept of costs includes only explicit costs (i.e. those that represent actual outlays of cash, the allocation of outlays of cash, or commitments to pay cash)
Examples include the incurrence of payables, the satisfaction of payables and the recognition of depreciation
What is the economic concept of cost?
The economic concept of costs includes both explicit and implicit cost
Implicit in any business decision is opportunity cost, defined as “the contribution to income that is forgone by not using a limited resource in its best alternative use”
Example: A manufacturer’s accounting cost for a new product line consists only of the costs associated with the new machinery and personnel, but the economic cost includes the 4.75% return the company could make by simply investing the money in certificates of deposit
What are Explicit costs?
Explicit costs are those requiring actual cash disbursements. For this reason, they are sometimes called out-of-pocket or outlay costs
Explicit costs are accounting costs (they are recognized in a firm’s accounting records)
What are Implicit costs?
Implicit costs are those costs not recognized in a firm’s formal accounting records
Implicit costs are opportunity costs
To measure the true economic success or failure of a venture, a company must add up more than the explicit costs that can easily be found in accounting records
a. Opportunity costs are the most important implicit costs
b. A normal profit is a crucial implicit cost
What are Economic costs?
Economic costs are total costs - the true hurdle for an economic decision is whether the revenues from the venture will cover all costs, both explicit and implicit
What is Accounting profit?
Accounting profits are earned when the (book) income of an organization exceed the (book) expenses
What is Economic profit?
Economic profits are a significantly higher hurdle. They are not earned until the organization’s income exceeds not only costs as recorded in the accounting records, but the firm’s implicit cost as will
Economic profit is also called pure profit
What is Marginal revenue?
Marginal revenue is the additional (also called incremental) revenue produced by generating one additional unit of output. Mathematically, it is the difference in total revenue at each level of output
If the product is being sold in a competitive market (i.e. the seller does not have monopoly power), the seller typically must cut its price to sell additional units
Thus, while total revenue keeps increasing with the sale of additional units, it increases by ever smaller amounts. This is reflected in a constantly decreasing marginal revenue
What is Marginal cost?
Marginal cost is the additional (also called incremental) cost incurred by generating one additional unit of output. Mathematically, it is the difference in total cash at each level of output
Typically, unit cost decreases for a while as the process becomes more efficient. Past a certain point, however, the process becomes less efficient and unit cost increases
Thus, while total cost increases gradually for a while, at some point it begins to increase sharply. This is reflected in a decreasing then increasing marginal cost
What is Profit maximization?
The firm’s goal is to maximize profits (not revenues). Thus, marginal revenue data must be compared with marginal cost data to determine the point of profit maximization
This occurs where marginal revenue equals marginal cost. Beyond this point, increasing production results in a level of costs so high that total profit is diminished
This is a crucial principle for marginal analysis: Profit is maximized at the output level where marginal revenue = marginal cost
How does Average fixed cost (AFC) behave in the short-run?
Short-run cost relationships
Average fixed cost (AFC) declines for as long as production increases. This is because the fixed amount of cost is being spread over more and more units
AFC is thus an asymptotic function, always approaching the x-axis without ever intersecting it
How does Average variable cost (AVC) behave in the short-run?
(Short-run cost relationships)
Average variable cost (AVC) declines quickly and then gradually begins increasing
How does Average total cost (ATC) behave in the short-run?
Short-run cost relationships
Average total cost (ATC) behaves similarly to average variable cost (AVC) by declining quickly and then begins a gradual increase
ATC = AFC + AVC
Thus, the distance between the ATC and AVC curves is always the same as the distance between the AFC curve and the x-axis
