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7: Cost and Industry Structure
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- 7.1: Prelude to Cost and Industry Structure
- In less than two decades, Amazon.com has transformed the way books are sold, bought, and even read. A major reason for the giant retailer’s success is its production model and cost structure, which has enabled Amazon to undercut the prices of its competitors even when factoring in the cost of shipping. Read on to see how firms great (like Amazon) and small (like your corner deli) determine what to sell, at what output and price.
- 7.2: Explicit and Implicit Costs, and Accounting and Economic Profit
- We can distinguish between two types of cost: explicit and implicit. Explicit costs are out-of-pocket costs, i.e., payments that are actually made. Wages that a firm pays its employees or rent that a firm pays for its office are explicit costs. Implicit costs are more subtle; they represent the opportunity cost of using resources already owned by the firm. These definitions are important for distinguishing between two conceptions of profit, accounting profit and economic profit.
- 7.3: The Structure of Costs in the Short Run
- The cost of producing a firm’s output depends on how much labor and physical capital the firm uses. However, the cost structure of all firms can be broken down into some common underlying patterns. When a firm looks at its total costs of production in the short run, a useful starting point is to divide total costs into two categories: fixed costs that cannot be changed in the short run and variable costs that can be changed.
- 7.4: The Structure of Costs in the Long Run
- The long run is the period of time when all costs are variable. The long run depends on the specifics of the firm in question—it is not a precise period of time. If you have a one-year lease on your factory, then the long run is any period longer than a year, since after a year you are no longer bound by the lease. No costs are fixed in the long run. A firm can build new factories and purchase new machinery, or it can close existing facilities.
- 7.E: Cost and Industry Structure (Exercises)