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    Module 1 Part 3

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    Sabir Ali
    The document discusses different types of costs that are relevant to profit maximization including opportunity costs, fixed costs, sunk costs, and variable costs. It explains that opportunity costs refer to the value of the next best alternative given up. Fixed costs do not change with output quantity while variable costs do change with output. Total costs equal the sum of fixed and variable costs.

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    Module 1 Part 3

    Uploaded by

    Sabir Ali
    11 views2 pages
    The document discusses different types of costs that are relevant to profit maximization including opportunity costs, fixed costs, sunk costs, and variable costs. It explains that opportunity costs refer to the value of the next best alternative given up. Fixed costs do not change with output quantity while variable costs do change with output. Total costs equal the sum of fixed and variable costs.

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    The document discusses different types of costs that are relevant to profit maximization including opportunity costs, fixed costs, sunk costs, and variable costs. It explains that opportunity costs refer to the value of the next best alternative given up. Fixed costs do not change with output quantity while variable costs do change with output. Total costs equal the sum of fixed and variable costs.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    11 views2 pages

    Module 1 Part 3

    Uploaded by

    Sabir Ali
    The document discusses different types of costs that are relevant to profit maximization including opportunity costs, fixed costs, sunk costs, and variable costs. It explains that opportunity costs refer to the value of the next best alternative given up. Fixed costs do not change with output quantity while variable costs do change with output. Total costs equal the sum of fixed and variable costs.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 2

    Module 1: Part 3

    The Profit Maximizing Framework: Set-up and Costs

    Output and Costs:

    Now we need to look at the other side of profits more carefully – costs.

    That is, what is the relationship between our decision (Q) and our costs (TC)?

    The main point in this section is that there are a wide variety of costs, some of which are
    important to our decisions and others that aren’t. So our goal is to describe these costs,
    and represent them with an equation that we can use to make our decision to maximize
    profits.

    Step 1: Opportunity Costs

    Remember, we are trying to improve our decision-making process. A key to good


    decision-making is understanding what you give up when you make a certain decision.

    Opportunity costs of a decision is the value of the next best alternative given up.

    For example, what are the opportunity costs of:


    1. attending this program
    2. saving for you children’s education

    In economics, when we identify TC, and hence total profits, we implicitly include
    opportunity costs.

    As such, we make a distinction between economic profits and accounting profits:

    Economic profits are revenues minus all costs (including opportunity costs)
    Accounting profits are revenues minus only those costs you actually pay (called explicit
    costs).

    Step 2: Fixed Costs:

    There are some costs that, during the output choice period, do NOT change when we
    change our output decision. We call these costs “fixed costs” because they do not change
    when we alter our decision.

    Examples of fixed costs:


     rent
     painting example

    Step 3: Sunk Costs:

    Sunk costs are costs that are nonrecoverable – there is nothing that can be done to recoup
    them.

    For example: Suppose I buy a $7 ticket for a movie, and while I go back to my car to
    pick up something I lose my ticket and cannot get a refund. Should I buy another ticket?

    The $7 is sunk, and as the old saying goes – don’t cry over spilt milk….

    Sunk costs do NOT influence your decision!

    Step 4: Variable Costs:

    These are costs that will change when we change our output choice. When we want to
    produce more we need more materials, more labor, more capital use, ect.

    An important question is how do variable costs change when we change our output?

    This is a question that we will explore in more detail later…

    Step 5: Total Costs

    Let’s put the picture together, and examine total costs…

    Total costs are fixed + variable costs: TC = FC + VC

    FC are a constant number: For example FC = 3.

    Variable costs will depend upon how much we produce (Q): For example, VC = 5Q.

    Overall, we have: TC = 3 + 5Q which shows us the relationship between our decision


    (Q) and the other half of profits – total costs.

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