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Chapter 9
Businesses and the Costs of Production
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9-2
Economic Costs
• The payment that must be made to obtain and retain the services of a resource
• Explicit costs• Monetary outlay
• Implicit costs• Opportunity cost of using self-owned resources• Value of next-best use• Includes a normal profit
LO1
9-3
Accounting Profit and Normal Profit
• Accounting profit = Total revenue – explicit costs• Economic profit = Accounting profit – implicit costs• Economic profit (to summarize) = Revenue – economic cost = Revenue – explicit costs – implicit costs
LO1
9-4
Explicitcosts
Accounting costs (explicit costs
only)
Implicit costs (including a
normal profit)
Economicprofit
Accounting profit
Econ
omic
(o
ppor
tuni
ty)
cost
s
Tota
l rev
enue
LO1
Economic Profit
9-5
Short Run and Long Run
• Short run• Some variable inputs• Fixed plant
• Long run• All inputs are variable• Firms can adjust plant size as well as enter
and exit industry
LO2
9-6
Short Run Production Relationships
• Total product (TP)• Marginal product (MP)
• Average product (AP)
LO2
Marginal product change in total product change in labor input
=
Average product total product units of labor
=
9-7
Law of Diminishing Returns
• Law of diminishing returns• Resources are of equal quality• Technology is fixed• Variable resources are added to fixed
resources• At some point, marginal product will fall
• Rationale
LO2
9-8
Total, Marginal, and Average Product: The Law of Diminishing Returns
(1)Units of the Variable
Resource (Labor)
(2)Total Product (TP)
(3)Marginal Product
(MP)Change in (2)/ Change in (1)
(4)Average Product
(AP),(2)/(1)
0 0 -
1 10 10 Increasingmarginalreturns
10.00
2 25 15 12.50
3 45 20 15.00
4 60 15Diminishing
marginalreturns
15.00
5 70 10 14.00
6 75 5 12.50
7 75 0 10.71
8 70 -5 Negativemarginalreturns
8.75
7-8
The Law of Diminishing Returns
9-9
The Law of Diminishing Returns
TP
MP
AP
IncreasingMarginalReturns
DiminishingMarginalReturns
NegativeMarginalReturns
1 2 3 4 5 6 7 8 90
10
20
30To
tal p
rodu
ct, T
P
1 2 3 4 5 6 7 8 9
20
10
Mar
gina
l pro
duct
, MP
LO2
9-10
Short Run Production Costs
• Fixed costs (TFC)• Costs that do not vary with output
• Variable costs (TVC)• Costs that do vary with output
• Total cost (TC)• Sum of TFC and TVC• TC = TFC + TVC
LO3
9-11
Cost
s
1 2 3 4 5 6 7 8 9 100 Q
100
200
300
400
500
600
700
800
900
1000
$1100
TFC
TC
TVC
Totalcost
Variablecost
Fixedcost
LO3
Short-Run Production Costs
9-12
Per-Unit, or Average, Costs
• Average fixed cost AFC = TFC/Q• Average variable cost AVC = TVC/Q• Average total cost ATC = TC/Q• Marginal cost MC = ΔTC/ΔQ
LO3
9-13
Short-Run Production Costs
LO3
Total, Average, and Marginal Cost Schedules for an Individual Firm in the Short Run
Total Cost Data Average Cost Data Marginal Cost
(1)Total Product
(Q)
(2)Total Fixed Cost
(TFC)
(3)Total Variable
Cost(TVC)
(4)Total Cost (TC)
TC=TFC+TVC
(5)Average Fixed
Cost(AFC)
AFC = TFC/Q
(6)AverageVariable
Cost (AVC)
AVC=TVC/Q
(7)Average Total
Cost(ATC)
ATC = TC/Q
(8)Marginal Cost
(MC)MC =ΔTC/ΔQ
0 $100 $0 $100
1
100
90 190 $100.00 $90.00 $190.00 $90
2 100 170 270 50.00 85.00 135.00 80
3 100 240 340 33.33 80.00 113.33 70
4 100 300 400 25.00 75.00 100.00 60
5 100 370 470 20.00 74.00 94.00 70
6 100 450 550 16.67 75.00 91.67 80
7 100 540 640 14.29 77.14 91.43 90
8 100 650 750 12.50 81.25 93.75 110
9 100 780 880 11.11 86.67 97.78 130
10 100 930 1030 10.00 93.00 103.00 150
7-13
9-14
Per-Unit, or Average, Costs
Cost
s
1 2 3 4 5 6 7 8 9 100 Q
50
100
150
$200
AFC
ATCAVC
AVC
AFC
LO3
9-16
Marginal Cost and Marginal Product
MPAP
MCAVC
Quantity of output
Quantity of labor
Cost curvesLO3
9-17
Long Run Production Costs
• The firm can change all input amounts, including plant size
• All costs are variable in the long run• Long run ATC• Different short run ATCs
LO4
9-19
The Long-Run Cost Curve
Long-runATC
Aver
age
tota
l cos
ts ATC-1
ATC-2
ATC-3 ATC-4
ATC-5
Output
LO4
9-20
Economies of Scale
• Economies of scale• Labor specialization• Managerial specialization• Efficient capital• Other factors
• Constant returns to scale
LO4
9-21
Diseconomies of Scale
• Diseconomies of scale• Control and coordination problems• Communication problems• Worker alienation• Shirking
LO4
9-22
MES and Industry Structure
• Minimum efficient scale (MES)• Lowest level of output at which long run
average costs are minimized• Can determine the structure of the industry
• Natural monopoly• Long run costs are minimized when one
firm produces the product
LO4
9-23
MES and Industry Structure
Output
Aver
age
tota
l cos
ts
Long-runATC
Economiesof scale
Constant returnsto scale
Diseconomiesof scale
q1 q2
LO5
9-24
MES and Industry Structure
Output
Aver
age
tota
l cos
ts
Economiesof scale
Diseconomiesof scale
Long-runATC
LO5
9-25
MES and Industry Structure
Output
Aver
age
tota
l cos
ts
Long-runATC
Economiesof scale
Diseconomiesof scale
LO5
9-26
Applications and Illustrations
• Rising gasoline prices• Successful start-up firms• Verson stamping machine• The daily newspaper• Aircraft and concrete plants
LO5
9-27
3D Printers and Mass Customization
• First industrial revolution began in 1700s• Mass production led to mass affordability• Second industrial revolution began late 1800s• Mass sales were necessary to spread R&D
costs• Third industrial revolution is beginning Now• Affordable mass customization with zero
transportation costs