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  Cost Concepts: Opportunity Cost ã Opportunity Cost(also called Alternative Cost  ): the expected returns from the second best use of resources which are foregone due to the scarcity of resources. Had the resources available to a person, a firm, or a society been unlimited there would be no opportunity cost. Project A: Expected return -- Tk. 2000 Project B: Expected return -- Tk. 1500 Project C: Expected return -- Tk. 1200   Example-1:  A profit maximizing firm would select Project A. And the opportunity cost of Project A is the Expected Return of the Project B -- the next best alternative foregone. Example-2:  What is the opportunity cost of doing MBA in DU EMBA Program? The cost of tuition, books, and travel averaged about Tk. 10,000. Does this mean that Tk. 10,000 was your opportunity cost of going to school? Definitely not! You must include as well the opportunity cost of the time spent studying and going to classes. If you take study-leave without pay from your firm you are loosing, say, Tk.15,000 per month. If we add up both the actual expenses and the earnings foregone, we would find that the opportunity cost of doing MBA is Tk.25,000 (equal to Tk. 10,000 + Tk. 15,000) rather than Tk. 10,000 per year.  Cost Concepts  ã Full Costs (or economic cost)= Business Cost   -- all the expenses which are incurred to carry out a business . +   Opportunity Cost -- . + Normal profit -- the minimum return that is necessary to keep the factors of production from moving to some other firm or industry.   ã Normal Profit : Because all opportunity costs must be accounted for, the proper concept of cost includes a normal payment to all inputs, including managerial and entrepreneurial skills and capital supplied by the owners of the firm. A normal return to management or capital is the minimum payment necessary to keep those resources from moving to some other firm or industry. Thus, cost includes a normal rate of profit. The term economic profit refers to profit in excess of these normal returns. That is, economic profit is defined as revenue less all economic costs. ã A firm earning zero economic profit generally would show a positive profit on the income statement prepared by its accountants.  ost urves: Total Cost = Total Fixed Cost + Total Variable Cost   ã The distinction between Fixed Cost and Variable Cost applies only to a short period ã Nothing can be remain fixed   for a long time. In the long run -- staff would change, capital would be different, dimensions of factory, too, may change. Hence, in the long run, all costs are variable. ã Short run: short run is that period during which two conditions   hold -- (i) existing firms face limits imposed by some fixed factors of production, and (ii) new firms cannot enter, and existing firms cannot exit, an industry. ã Total Fixed Cost(TFC) (also called overhead)  : those costs which do not change with the level of output in the short run, such as -- salary of the executives, rent, etc. ã Total Variable Cost: those costs which change with the level of output, such as - - raw material, direct labor, etc.    Cost Curves: Fixed Costs ã Total Fixed Costs (TFC): Because TFC does not change with output, the graph is simply a straight horizontal line ã Average Fixed Costs (AFC): AFC = TFC/q . AFC falls as output rises, because the same total is being spread over  , or divided by, a large number of units. q   0 1 2 3 4 5 TFC AFC (=TFC/q) Tk. 1000 1000 1000 1000 1000 1000 Tk. -- 1000 500 333 250 200 Short-Run Fixed Cost (Total and Average)   of a Hypothetical Firm   Table: TFC 1000 0 1 2 3 4 5 TFC q AFC q 0 1 2 3 4 5 AFC 1000 500 333 250 200
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