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Econ 204 week 7 outline
1.
Prepared By Brock
Williams Chapter 8 Production Technology and Cost Consider the challenge of providing safe water to rural families in less developed countries.
2.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-2 1. Define economic cost and economic profit 2. Draw the short-run marginal-cost and average-cost curves 3. Draw the long-run marginal-cost and average cost curves 4. Provide examples of production costs Learning Objectives
3.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-3 ● economic profit Total revenue minus economic cost. ● economic cost The opportunity cost of the inputs used in the production process; equal to explicit cost plus implicit cost. economic profit = total revenue – economic cost P R I N C I P L E O F O P P O R T U N I T Y C O S T The opportunity cost of something is what you sacrifice to get it. 8.1 ECONOMIC COST AND ECONOMIC PROFIT
4.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-4 ● explicit cost A monetary payment. ● implicit cost An opportunity cost that does not involve a monetary payment. 8.1 ECONOMIC COST AND ECONOMIC PROFIT (cont.) TABLE 8.1 Economic Cost versus Accounting Cost
5.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-5 OPPORTUNITY COST AND ENTREPENEURSHIP APPLYING THE CONCEPTS #1:What is the opportunity cost of an entrepreneur? • What’s the opportunity cost of an entrepreneur? • For many entrepreneurs, starting a new business means leaving paid employment. In other words, businesses are started by people with relatively low wages. • After controlling for gender, age, education, marital status, and region, the wage gap between workers who become entrepreneurs and workers who remain in paid employment was about 12 percent. A P P L I C A T I O N 1 8.1 ECONOMIC COST AND ECONOMIC PROFIT (cont.)
6.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-6 economic cost = explicit cost + implicit cost accounting cost = explicit cost accounting profit = total revenue − accounting cost ● accounting cost The explicit costs of production. ● accounting profit Total revenue minus accounting cost. 8.1 ECONOMIC COST AND ECONOMIC PROFIT (cont.)
7.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-7 Production and Marginal Product ● marginal product of labor The change in output from one additional unit of labor. ● diminishing returns As one input increases while the other inputs are held fixed, output increases at a decreasing rate. P R I N C I P L E O F D I M I N I S H I N G R E T U R N S Suppose output is produced with two or more inputs, and we increase one input while holding the other input or inputs fixed. Beyond some point—called the point of diminishing returns—output will increase at a decreasing rate. 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS
8.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-8 Production and Marginal Product ● total-product curve A curve showing the relationship between the quantity of labor and the quantity of output produced, ceteris paribus. 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
9.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-9 Production and Marginal Product FIGURE 8.1 Total-Product Curve The total-product curve shows the relationship between the quantity of labor and the quantity of output, given a fixed production facility. For the first two workers, output increases at an increasing rate because of labor specialization. Diminishing returns occurs for three or more workers, so output increases at a decreasing rate. 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
10.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-10 Short-Run Total Cost ● fixed cost (FC) Cost that does not vary with the quantity produced. ● variable cost (VC) Cost that varies with the quantity produced. ● short-run total cost (TC) The total cost of production when at least one input is fixed; equal to fixed cost plus variable cost. TC = FC + VC 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
11.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-11 Short-Run Total Cost FIGURE 8.2 Short-Run Costs: Fixed Cost, Variable Cost, and Total Cost The short-run total-cost curve shows the relationship between the quantity of output and production costs, given a fixed production facility. Short-run total cost equals fixed cost (the cost that does not vary with the quantity produced) plus variable cost (the cost that varies with the quantity produced). 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.) TABLE 8.2 Short-Run Costs
12.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-12 Short-Run Average Costs ● average fixed cost (AFC) Fixed cost divided by the quantity produced. ● average variable cost (AVC) Variable cost divided by the quantity produced. 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
13.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-13 Short-Run Average Costs FIGURE 8.3 Short-Run Average Costs The short-run average-total-cost curve (ATC) is U-shaped. As the quantity produced increases, fixed costs are spread over more and more units, pushing down the average total cost. In contrast, as the quantity increases, diminishing returns eventually pulls up the average total cost. The gap between ATC and AVC is the average fixed cost (AFC). 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
14.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-14 Short-Run Average Costs ● short-run average total cost (ATC) Short-run total cost divided by the quantity produced; equal to AFC plus AVC. 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
15.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-15 Short-Run Marginal Cost ● short-run marginal cost (MC) The change in short-run total cost resulting from a one-unit increase in output. 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
16.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-16 The Relationship between Marginal Cost and Average Cost FIGURE 8.4 Short-Run Marginal and Average Cost The marginal-cost curve (MC) is negatively sloped for small quantities of output, because of the benefits of labor specialization, and positively sloped for large quantities, because of diminishing returns. The MC curve intersects the average-cost curve (ATC) at the minimum point of the average curve. At this point ATC is neither falling nor rising. 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.)
17.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-17 • Consider the following simple production process. A firm that simply digs holes has a fixed amount of capital (10 standard shovels) and can vary the number of workers. • Armed with a standard shovel, a worker requires two hours to dig one hole. To produce one hole per day, the firm hires a worker and uses only one of its 10 shovels. • If the wage is $12 per hour, the marginal cost of the first dug hole is $24. As the quantity of output increases, the firm adds workers and uses more of its shovels, and the marginal cost remains at $24 for the first 10 holes. • In this case, marginal cost is constant for the first 10 units of output because the firm doesn’t experience diminishing returns. Idle Capital and Short-Run Marginal Cost APPLYING THE CONCEPTS #2: Why is the marginal-cost curve positively sloped? A P P L I C A T I O N 2
18.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-18 The Relationship between Marginal Cost and Average Cost 8.2 A FIRM WITH A FIXED PRODUCTION FACILITY: SHORT-RUN COSTS (cont.) TABLE 8.3 Marginal Grade and Average Grade
19.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-19 Expansion and Replication ● long-run total cost (LTC) The total cost of production when a firm is perfectly flexible in choosing its inputs. ● long-run average cost (LAC) The long-run cost divided by the quantity produced. 8.3 PRODUCTION AND COST IN THE LONG RUN
20.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-20 Expansion and Replication ● constant returns to scale A situation in which the long-run total cost increases proportionately with output, so average cost is constant. ● long-run marginal cost (LMC) The change in long-run cost resulting from a one-unit increase in output. 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
21.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-21 Expansion and Replication FIGURE 8.5 The Long-Run Average-Cost Curve and Scale Economies The long-run average-cost curve (LAC) is negatively sloped for up to 10 paddles per day, a result of indivisible inputs and the effects of labor specialization. If the firm replicates the operation that produces 10 paddles per day, the long run average-cost curve will be horizontal beyond 10 paddles per day. 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
22.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-22 Reducing Output with Indivisible Inputs ● indivisible input An input that cannot be scaled down to produce a smaller quantity of output. 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
23.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-23 Scaling Down and Labor Specialization • Labor specialization makes workers more productive because of continuity and repetition. • When we reduce the workforce each worker will become less specialized, performing a wider variety of production tasks. • The loss of specialization will decrease labor productivity, leading to higher average cost. 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
24.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-24 Economies of Scale ● economies of scale A situation in which the long-run average cost of production decreases as output increases. ● minimum efficient scale The output at which scale economies are exhausted. 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
25.
Copyright ©2014 Pearson
Education, Inc. All rights reserved. 8-25 Diseconomies of Scale ● diseconomies of scale A situation in which the long-run average cost of production increases as output increases. 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
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Education, Inc. All rights reserved. 8-26 Actual Long-Run Average-Cost Curves FIGURE 8.6 Actual Long-Run Average-Cost Curves for Aluminum, Truck Freight, and Hospital Services 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
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Education, Inc. All rights reserved. 8-27 Short-Run versus Long-Run Average Cost • The difference between the short run and long run is a firm’s flexibility in choosing inputs. 8.3 PRODUCTION AND COST IN THE LONG RUN (cont.)
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Education, Inc. All rights reserved. 8-28 Indivisible Inputs and the Cost of Fake Killer Whales APPLYING THE CONCEPTS #3: How do indivisible inputs affect production costs? A P P L I C A T I O N 3 • Sea lions off the Washington coast eat steelhead and other fish, depleting some species threatened with extinction and decreasing the harvest of the commercial fishing industry. • Rick Funk is a plastics manufacturer who has offered to build a life-sized fiberglass killer whale, mount it on a rail like a roller coaster, and send the whale diving through the water to scare off the sea lions, whales’ natural prey. • According to Funk, it would cost about $16,000 to make the first whale, including $11,000 for the mold and $5,000 for labor and materials. Once the mold is made, each additional whale would cost an additional $5,000. • In other words, the cost of producing the first fake killer whale is more than three times the cost of producing the second.
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Education, Inc. All rights reserved. 8-29 Examples of Production Cost There are scale economies in the production of electricity from wind because electricity can be generated from turbines of different sizes. Although large wind turbines are more costly than small ones, the higher cost is more than offset by greater generating capacity. The scale economies occur because the cost of purchasing, installing, and maintaining a wind turbine increases less than proportionately with the turbine’s generating capacity. Scale Economies in Wind Power TABLE 8.5 Wind Turbines and the Average Cost of Electricity
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Education, Inc. All rights reserved. 8-30 FIGURE 8.7 Average-Cost Curve for an Information Good For an information good such as a music video, the cost of producing the first copy is very high, but the marginal cost of reproduction is relatively low, and for products distributed online, the marginal cost is zero. The Average Cost of a Music Video
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Education, Inc. All rights reserved. 8-31 Summary TABLE 8.6 The Language and Mathematics of Costs
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Education, Inc. All rights reserved. 8-32 accounting cost accounting profit average fixed cost (AFC) average variable cost (AVC) constant returns to scale diminishing returns diseconomies of scale economic cost economic profit economies of scale explicit cost fixed cost (FC) implicit cost indivisible input long-run average cost (LAC) long-run marginal cost (LMC) long-run total cost (LTC) marginal product of labor minimum efficient scale short-run average total cost (ATC) short-run marginal cost (MC) short-run total cost (TC) total-product curve variable cost (VC) K E Y T E R M S
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