Mic 7

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Mic 7

  1. 1. Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 MICROECONOMICS 17– 1
  2. 2. CHAPTER 7 Cost of Production Microeconomics All Rights Reserved © Oxford University Press Malaysia, 2008 7– 2
  3. 3. THE COST CONCEPTS Value of input services that are used in IMPLICIT COST production but not purchased in a market. COST CONCEPTS Total cost of production of a good that SOCIAL COST includes direct and indirect costs. The value of a resource in its OPPORTUNITY COST next best use. Value of resources purchased for EXPLICIT COST production. The cost that a firm cannot recover from SUNK COST the expenditure it has made.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 3
  4. 4. THE COST OF PRODUCTION SHORT RUN A production period in which at least one of the input is fixed* LONG RUN A production period in which all the inputs are variable** * A fixed input is an input in which the quantity does not change according to the amount of output, e.g. machinery. ** A variable input is an input in which the quantity varies according to the amount of output, e.g. labour.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 4
  5. 5. SHORT-RUN PRODUCTION COST TOTAL COST (TC)  The sum of cost of all inputs used to produce goods and services.  Total cost (TC ) is also defined as total fixed cost (TFC) plus total variable cost (TVC). TC = TFC + TVC TOTAL FIXED COST (TFC) TOTAL VARIABLE COST (TVC)  The cost of inputs that is  The cost of inputs that changes independent of output. with output.  Examples, factory,  Examples, raw materials, machinery, etc. labours, etc.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 5
  6. 6. SHORT-RUN PRODUCTION COST (CON’T) AVERAGE TOTAL COST (ATC) The total cost per unit of output . The formula for average total cost (ATC) is the total cost (TC) divided by the output (Q) AC = TC Q OR TC = TFC + TVCMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 6
  7. 7. SHORT-RUN PRODUCTION COST (CON’T) AVERAGE FIXED COST (AFC) Total fixed cost (TFC) divided by total output. AFC = TFC Q AVERAGE VARIABLE COST (AVC) Total variable cost (TVC) divided by total output. AVC = TVC Q MARGINAL COST (MC) The change in total cost that results from a change in output; the extra cost incurred to produce another unit of output. MC = ∆TC ∆QMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 7
  8. 8. COSTS AT VARIOUS QUANTITES Total costs Average costs (1) (2) (3) (4) (5) (6) (7) (8) Quantity Total Total Total Average Average Average total Marginal (Q) fixed variable cost fixed cost variable cost cost (MC) cost cost (TC) (AFC) cost (AVC) (ATC) (TFC) (TVC) TC=TF AFC = AVC = ATC = TC/Q MC = C+TVC TFC/Q TVC/Q ∆TC/∆Q (4) / (1) or (5) (2) + (3) (2)/(1) (3) / (1) + (6) ∆(4) /∆(1) 20 0 20 - - - - 1 0 20 15 35 20 15 35 15 2 20 25 45 10 12.50 22.50 10 3 20 30 50 6.67 10 16.67 5 4 20 35 55 5 8.75 13.75 5 5 20 45 65 4 9 13 10Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 8
  9. 9. THE RELATIONSHIP BETWEEN COST CONCEPTS Cost MC ATC AVC AFC Quantity The marginal cost cuts through the minimum point of ATC and AVCMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 9
  10. 10. THE RELATIONSHIP BETWEEN MC AND AVC Cost ATC falling, MC curve lies below MC ATC curve. ATC is ATC at minimum point. ATC curve and MC curve are equal. ATC starts to increase. MC curve lies above ATC curve. QuantityMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 10
  11. 11. THE RELATIONSHIP BETWEEN PRODUCTIVITY AND COST Production AP equal to MP, AP MP AP curve is at maximum. AVC equal to MC , AVC Labour curve is at minimum. Cost MC AVC QuantityMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 11
  12. 12. ISOCOST An isocost line shows various combinations of two inputs, capital and labour, which can be purchased with a given amount of money for a given total cost. An isocost equation shows the relationship between the inputs (capital and labour) used in the production and the given total cost by a firm.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 12
  13. 13. ISOCOST EQUATION • The isocost equation can be written as: TC = wL + rK Where TC = Total cost L = Labour K = Capital (fixed) w = Price of labour r = Price of capitalMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 13
  14. 14. ISOCOST LINE Isocost Line 6 5 4 Capital 3 Isocost 2 1 0 0 1 2 3 4 5Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 14
  15. 15. ISOCOST MAP An isocost map is a number of isocost lines that show different levels of total cost in one diagram. 7 6 5 Isocost (RM100) 4 Capital 3 Isocost (RM120) 2 1 0 0 1 2 3 4 5 6Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 15
  16. 16. COST MINIMIZING TECHNIQUES Cost minimizing techniques is selecting a combination of inputs that minimize the total cost at a given level of output.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 16
  17. 17. COST MINIMIZING TECHNIQUES At point y, the slope of isoquant curve is equal to that of isocost line and this is the most efficient technique for production. Labour 7 6 5 x Isocost (RM100) 4 Capital 3 Isocost (RM120) y 2 Isocost z 1 0 0 1 2 3 4 5 6 Points x and z are not efficient because the cost of production is exceeding RM120.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 17
  18. 18. LONG-RUN PRODUCTION COST Long run is a period where there are only variable factors and no fixed cost involved. Long run total cost (LRTC) starts from origin because of the absence of total fixed cost. LONG-RUN AVERAGE COST CURVE (LRAC) This shows the minimum cost of producing any given output when all of the inputs are variable. Long run is a period where firms plan how to minimize average cost.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 18
  19. 19. LONG-RUN PRODUCTION COST CURVE LRAC curve are derived by a series of short-run average cost curves. AC SRAC1 SRAC5 SRAC2 LRAC SRAC4 SRAC3 QuantityMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 19
  20. 20. LONG-RUN PRODUCTION COST CURVE• Long-run average cost curve (LRAC) is U-shaped due to the Law of Returns to Scale• Law of Returns to Scale states that as the firm expand its size or scale of production, its long-run average cost (LRAC) will decrease and increase at a later stage. Cost LRAC Increasing Constant Decreasing Return to Return to Return to Scale Scale Scale Quantity Microeconomics All Rights Reserved © Oxford University Press Malaysia, 2008 7– 20
  21. 21. ECONOMIES OF SCALE • Advantages and benefits of a firm as it becomes larger and larger. • Reduced long-run average cost (LRAC). • Marketing economies, financial economies, labour economies, technical economies and managerial economies.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 21
  22. 22. DISECONOMIES OF SCALE • Problems faced by a firm as it becomes larger and larger. • Decreased long-run average cost (LRAC). • Mismanagement, competition and labour diseconomies.Microeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 22
  23. 23. ECONOMIES OF SCALE Economies of scale are benefits and advantages of a firm as it expands its production. Economies of scale reduces the average cost. INTERNAL EXTERNAL Internal economies happen Advantages of the industry as a inside an organization whole Labour Economies Economies of Government Managerial Economies Action Marketing Economies Economies of Concentration Techical Economies Risk Bearing Economies Economies of Information Transport and Storage Economies Economies of MarketingMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 23
  24. 24. DISECONOMIES OF SCALE Diseconomies of scale are problems and disadvantages faced by a firm when it expands production. Diseconomies of scale increases the average cost. INTERNAL EXTERNAL Raise the cost of production of a The disadvantages faced by the firm as the firm expands industry as a whole Labour Diseconomies Scarcity of Raw Material Managerial Problem Wage Differential Technical Difficulties Concentration ProblemMicroeconomics All Rights Reserved© Oxford University Press Malaysia, 2008 7– 24

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