7.2 Production, Costs, and Profits LO 2
The production function relates inputs of factor services to output.
Accounting profit is the difference between the firm’s revenues and
its explicit costs, including labour costs, capital costs, the costs of
intermediate inputs, and depreciation.
Economic profit is the difference between the firm’s revenues and
total costs, including both explicit and implicit costs. Implicit costs
include the opportunity cost of the owner’s time and capital.
Economic profits play a key role in resource allocation. Positive
economic profits attract resources into an industry; negative
economic profits induce resources to move elsewhere.
Economists divide the firm’s production decisions into three time
frames. The short run involves decisions in which one or more factors
of production are fixed. The long run involves decisions in which all
factors are variable but technology is unchanging. The very long run
involves decisions in which technology can change.