Compare and contrast the following concepts.
a) Explicit cost and implicit cost
b) Economic cost and accounting cost
2. What is the main difference between fixed inputs and variable inputs?
3. Explain the law of variable proportions.
4. Which stage of short run production is efficient? Why?
5. Show the relationship between short-run MC and MPL both mathematically and
graphically.
6. Can accounting cost be greater economic cost? Explain.
7. The short run AVC, AC and MC are all U-shaped. Why?
a) Explicit cost refers to the actual monetary payment that a firm makes for the use of a resource, while implicit cost refers to the opportunity cost of using a resource that is not explicitly paid for. Explicit costs are easily quantifiable and can be found in accounting records, while implicit costs are more subjective and rely on opportunity cost calculations.
b) Economic cost includes both explicit and implicit costs, as it considers the value of resources in their next best alternative uses. Accounting cost, on the other hand, only includes the explicit costs that are recorded in financial statements.
2. Fixed inputs are those inputs that do not vary with the level of output in the short run, such as rent or capital equipment. Variable inputs, on the other hand, are inputs that can be varied in the short run, such as labor or raw materials.
3. The law of variable proportions, also known as the law of diminishing marginal returns, states that as more units of a variable input are added to fixed inputs, the marginal product of the variable input will eventually decrease. This occurs due to limited resources and the increasing difficulty of efficiently combining the variable input with fixed inputs.
4. The stage of short-run production that is considered efficient is typically the stage where the marginal product of the variable input reaches its maximum. At this stage, each additional unit of the variable input contributes the most to total output, indicating the most efficient use of resources.
5. Mathematically, the relationship between short-run marginal cost (MC) and marginal product of labor (MPL) can be represented by the equation MC = ∆TC/∆Q = ∆VC/∆Q = w/∆Q, where MC is the change in total cost (TC) or variable cost (VC) divided by the change in quantity (Q), and w is the wage rate. Graphically, the relationship is shown by plotting the MC and MPL on the y-axis and the quantity of labor (or input) on the x-axis. The MC curve will intersect with the MPL curve at the point where MPL is at its maximum.
6. Yes, accounting cost can be greater than economic cost. This can occur when explicit costs are higher than the opportunity cost of using resources in their next best alternative uses. For example, a firm may choose to pay higher wages for labor to attract more skilled workers, even though they could hire less skilled workers at a lower cost. In this case, the accounting cost includes the higher wages, while the economic cost considers the opportunity cost of potentially hiring less skilled workers.
7. The U-shape of the short-run average variable cost (AVC), average cost (AC), and marginal cost (MC) curves is primarily due to the law of diminishing marginal returns. Initially, as more units of the variable input are added, specialization and increased efficiency lead to decreasing average costs. However, as the law of diminishing returns sets in, the additional units of the variable input lead to less efficient use of fixed inputs, causing average costs to increase. This results in the U-shaped curves observed.