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Chapter 9 Businesses and the Costs of
Produc2on 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
• Accoun3ng profit = Total revenue – explicit costs • Economic profit = Accoun2ng profit – implicit costs • Economic profit (to summarize) = Revenue – economic cost = Revenue – explicit costs – implicit costs
LO1
9-‐4
Explicit costs
Accoun3ng costs (explicit costs
only)
Implicit costs (including a
normal profit)
Economic profit
Accoun3ng profit
Econ
omic
(opp
ortunity)
costs
Total reven
ue
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
• Ra2onale
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 Increasing marginal returns
10.00
2 25 15 12.50
3 45 20 15.00
4 60 15 Diminishing marginal returns
15.00
5 70 10 14.00
6 75 5 12.50
7 75 0 10.71
8 70 -‐5 Nega2ve marginal returns
8.75
The Law of Diminishing Returns
9-‐9
The Law of Diminishing Returns
TP
MP
AP
Increasing Marginal Returns
Diminishing Marginal Returns
Nega3ve Marginal Returns
1 2 3 4 5 6 7 8 9 0
10
20
30 To
tal produ
ct, TP
1 2 3 4 5 6 7 8 9
20
10
Margina
l produ
ct, M
P
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
Costs
1 2 3 4 5 6 7 8 9 10 0 Q
100
200
300
400
500
600
700
800
900
1000
$1100
TFC
TC
TVC
Total cost
Variable cost
Fixed cost
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) Average Variable 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
9-‐14
Per-Unit, or Average, Costs
Costs
1 2 3 4 5 6 7 8 9 10 0 Q
50
100
150
$200
AFC
ATC AVC
AVC
AFC
LO3
9-‐16
Marginal Cost and Marginal Product
Average prod
uct a
nd
margina
l produ
ct
Cost (d
ollars)
MP AP
MC AVC
Quan3ty of output
Quan3ty of labor
Cost curves LO3
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-‐run ATC
Average total costs ATC-‐1
ATC-‐2
ATC-‐3 ATC-‐4
ATC-‐5
Output
LO4
9-‐20
Economies of Scale
• Economies of scale • Labor specializa2on • Managerial specializa2on • Efficient capital • Other factors
• Constant returns to scale
LO4
9-‐21
Diseconomies of Scale
• Diseconomies of scale • Control and coordina2on problems • Communica2on problems • Worker aliena2on • 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
Average total costs
Long-‐run ATC
Economies of scale
Constant returns to scale
Diseconomies of scale
q1 q2
LO5
9-‐24
MES and Industry Structure
Output
Average total costs
Economies of scale
Diseconomies of scale
Long-‐run ATC
LO5
9-‐25
MES and Industry Structure
Output
Average total costs
Long-‐run ATC
Economies of scale
Diseconomies of scale
LO5
9-‐26
Applications and Illustrations
• Rising gasoline prices • Successful start-‐up firms • Verson stamping machine • The daily newspaper • Aircrah and concrete plants
LO5
9-‐27
3D Printers and Mass Customization
• First industrial revolu2on began in 1700s • Mass produc2on led to mass affordability • Second industrial revolu2on began late 1800s • Mass sales were necessary to spread R&D costs
• Third industrial revolu2on is beginning Now • Affordable mass customiza2on with zero transporta2on costs