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Short Run and Long Run Costs Chapter 5 Pages 178-191
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What would you need to start a Panera? <ul><li>http://www.panerabread.com/about/franchise/ </li></ul>
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Short Run versus Long Run? <ul><li>short run - a period of time where some inputs are fixed (capital = building, equipment, etc.) </li></ul><ul><li>long run - a period of time in which all inputs can be varied (no inputs are fixed) </li></ul>
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Short Run Cost Function <ul><li>Definition: </li></ul><ul><li>A function that defines the minimum possible cost of producing each output level when variable factors are employed in the cost-minimizing fashion </li></ul>
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In this case, what is your total product/output (Q)? <ul><li>Number of Paninis (for simplicity assume that Panera only produces a single product) </li></ul><ul><li>In general a firm uses capital, labor and materials to produce the product/output. </li></ul>
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In Short Run, how does the number of Paninis produced change as you change the number of workers? 28 5 25 4 20 3 12 2 5 1 0 0 # of paninis # of workers
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How does output change if you hire one more person? <ul><li>Depends on how many workers you currently have. Output increase by 5 paninis when you hire the 1 st worker, increases by 7 paninis when you hire the 2 nd worker, …., and increases 3 paninis when you hire the 5 th worker. </li></ul>
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What happens to “productivity” as the first few employees are hired? <ul><li>Specialize and marginal product increases. </li></ul><ul><li>Marginal Product is the change in total output attributable to the last unit of an input. </li></ul>
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What would happen to “productivity” if you continued to hire more and more workers? <ul><li>Marginal product would start to fall because some inputs are fixed in the short run </li></ul><ul><li>Law of diminishing marginal returns OR Law of diminishing marginal product </li></ul>
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What costs would you have to pay even if you didn’t produce a single panini? <ul><li>Fixed Costs, FC (or Total Fixed Costs, TFC) </li></ul><ul><li>(often involves building and equipment) </li></ul><ul><li>Fixed Costs = Costs that do not change with changes in output </li></ul>
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What costs would you have to pay only if you produced paninis? <ul><li>Variable Costs, VC (or Total Variable Costs, TVC) </li></ul><ul><li>(often assumed to be labor and material) </li></ul><ul><li>Variable Costs = Costs that change with changes in output </li></ul>
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What costs would increase if we wanted to produce one more panini? <ul><li>Variable Costs (such as labor and materials) </li></ul>
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If you hired more and more employees <ul><li>and the store became more and more crowded until the marginal product of a worker started to fall, what would happen to the cost of producing one more panini (marginal cost)? </li></ul><ul><li>Marginal cost = cost of producing an additional unit of output </li></ul>
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What is happening to TC as Q increases? TC= ATC*Q 150 180 480 Increases!
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What are total fixed costs in this example? AFC*Q 100*1=100
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Why are AFC diminishing? Spreading a fixed number out over a larger and larger Q
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Why is AVC getting closer to ATC? Because ATC = AVC+AFC and AFC is getting close to 0
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Where does the law of diminishing marginal product set in and how do you know? Between Q = 4 and Q = 5 MC start increasing! Why does this happen? An input is fixed in the short run!
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Where does MC cross ATC? Where does MC cross AVC? At their minimums What is the relationship between MC and ATC? MC and AVC? If MC<ATC, ATC is decreasing If MC>ATC, ATC is increasing Same for AVC
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How do you know this is the short run? There are fixed costs
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Fixed Cost versus Sunk Cost <ul><li>Fixed Cost = costs that do not change with changes in output </li></ul><ul><li>Sunk Cost= a cost that is forever lost after it has been paid </li></ul><ul><li>Does profit maximizing output depend on whether cost if fixed or sunk given that you produce paninis? </li></ul><ul><li>Does the decision whether to produce any paninis depend on whether cost is fixed or sunk? </li></ul>
24.
Short Run versus Long Run? <ul><li>short run - a period of time where some inputs are fixed (capital = building, equipment, etc.) </li></ul><ul><li>long run - a period of time in which all inputs can be varied (no inputs are fixed) </li></ul>
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Returns to Scale in Long Run Production <ul><li>Is the increase in output proportional to the increase in “inputs”? </li></ul><ul><li>What is the marginal product of changing ALL inputs? </li></ul>
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Economies to Scale <ul><li>Exist when long-run average costs decline as output is increased. </li></ul><ul><li>Example in other words: to double output, you don’t have to double costs </li></ul><ul><li>Example in other words: if you double costs, you more than double the output </li></ul>
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Why does there exist Economies of Scale? <ul><li>Specialization in production - get more productive if specialize </li></ul><ul><li>Can spread some costs over everything (ex: advertising, R&D, capital investments) </li></ul><ul><li>Can command quantity discounts from suppliers </li></ul>
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Diseconomies of Scale <ul><li>Exist when long-run average costs rise as output is increased. </li></ul><ul><li>Example in other words: to double output, you have to more than double costs </li></ul><ul><li>Example in other words: if you double costs, you cannot double the output </li></ul>
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Why Diseconomies of Scale? <ul><li>Monitoring </li></ul><ul><li>Morale </li></ul><ul><li>Ex: </li></ul>
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Constant Returns to Scale <ul><li>Exist when long-run average costs remain constant as output is increased. </li></ul><ul><li>Example in other words: to double output, you have to double costs </li></ul>
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Specific Example: Each of the following represent SATC curves at 3 different factory sizes that are fixed in the short run: <ul><li>Short Run -At least one input is fixed. Typically assume capital is fixed and labor/material is variable. </li></ul><ul><li>Why do the ATC curves have the U-shape? </li></ul><ul><li>Law of diminishing marginal returns to variable input </li></ul><ul><li>Long Run - Nothing is fixed. </li></ul><ul><li>Each of the following represents a short run SATC curve at different levels of capital (building, equipment) </li></ul>
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Specific Example: Each of the following represent SATC curves at 3 different factory sizes that are fixed in the short run: <ul><li>Suppose we initially have a small factory and we’re producing one unit of output. If we want to increase output in the short run , how do we have to do it? </li></ul><ul><li> add more variable inputs </li></ul><ul><li>In the long run , is that the only option? </li></ul><ul><li>No, build a bigger factory </li></ul>
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Specific Example: 3 possible factory sizes <ul><li>The least expensive way to produce Q = 1 is with a ___________ factory. </li></ul><ul><li>The least expensive way to produce Q = 2 is with a ___________ factory. </li></ul><ul><li>The least expensive way to produce Q = 3 is with a ___________ factory. </li></ul><ul><li>The least expensive way to produce Q = 4 is with a ___________ factory. </li></ul><ul><li>The least expensive way to produce Q = 5 is with a ___________ factory. </li></ul><ul><li>The least expensive way to produce Q = 6 is with a ___________ factory. </li></ul>small small medium medium medium large large
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In the long run, you can choose any size factory you want...what is the LATC curve? LATC = Minimum of the SATCs! LATC ≤ SATC
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Where do Economies of Scale exist? LATC Economies of Scale
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Where do Diseconomies of Scale exist? LATC Diseconomies of Scale
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General Example – many possible levels of fixed inputs If these are many SATC, what does the LATC look like? LATC - minimum of SATC Why does the LATC curve have the U-shape? Economies of Scale Constant Returns to Scale Diseconomies of Scale Minimum Efficient Scale - lowest average costs
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