Production and Costs <ul><li>economic costs & profits  </li></ul><ul><li>short run  </li></ul><ul><li>long run </li></ul>
big picture <ul><li>understand behavior of firm </li></ul><ul><li>understand & measure </li></ul><ul><ul><li>production </...
I.  economic costs & profits <ul><li>firm’s goal: </li></ul><ul><li>maximize profit </li></ul><ul><li>look at factors that...
economic costs <ul><li>opportunity cost of resources used </li></ul><ul><li>explicit costs </li></ul><ul><ul><li>paid in m...
example: smoothie shop <ul><li>explicit costs: </li></ul><ul><ul><li>wages </li></ul></ul><ul><ul><li>interest on loan </l...
<ul><li>implicit costs </li></ul><ul><ul><li>forgone interest on funds used to buy capital </li></ul></ul><ul><ul><li>owne...
accounting profit <ul><li>total revenue – explicit costs </li></ul><ul><li>ignores opportunity cost </li></ul>
economic profit <ul><li>includes opp. costs </li></ul><ul><li>= total revenue - total costs </li></ul><ul><li>= (price)(qu...
normal profit <ul><li>occurs when </li></ul><ul><li>amount of accounting profit </li></ul><ul><li>= opportunity costs of r...
 
Short Run vs. Long Run <ul><li>Short Run (SR) </li></ul><ul><ul><li>time frame where some resources are fixed </li></ul></...
<ul><li>Long Run (LR) </li></ul><ul><ul><li>time frame where all inputs are variable </li></ul></ul><ul><ul><li>--build a ...
II.  SR Production <ul><li>measures of output </li></ul><ul><ul><li>total product </li></ul></ul><ul><ul><li>marginal prod...
total product (TP) <ul><li>total quantity of good produced </li></ul><ul><li>in a given period </li></ul><ul><li>at first,...
TP:  gal. of smoothies per hour # workers TP 0 1 2 3 4 5 6 7 0 1 3 6 8 9 9 8
TP # workers 5 6 9
marginal product (MP) <ul><li>change in TP due to one more worker </li></ul><ul><li>  </li></ul>= change in TP change in l...
At first MP rises with workers <ul><li>add more workers </li></ul><ul><li>greater specialization </li></ul><ul><li>MP of e...
then, MP falls with more workers <ul><li>keep adding workers </li></ul><ul><li>but same amount of capital </li></ul><ul><l...
TP, MP:  gal. of smoothies # workers TP 0 1 2 3 4 5 6 7 0 1 3 6 8 9 9 8 MP 1 2 3 -1 0 1 2
MP Q = # workers 0 3 3
law of decreasing returns <ul><li>As firm uses more labor </li></ul><ul><ul><li>with capital fixed,  </li></ul></ul><ul><u...
Average Product (AP) = TP labor = productivity
# workers TP 0 1 2 3 4 5 6 7 0 1 3 6 8 9 9 8 MP AP 1 1.5 2 2 1.8 1.5 1.1 1 2 3 -1 0 1 2
MP # workers AP 0 3 3
MP & AP <ul><li>MP intersects AP at max of AP </li></ul><ul><li>why? </li></ul><ul><li>MP > AP </li></ul><ul><ul><li>AP is...
III.  SR cost <ul><li>measure cost 3 ways: </li></ul><ul><ul><li>total cost </li></ul></ul><ul><ul><li>marginal cost </li>...
Total Cost (TC) <ul><li>cost of all factors used </li></ul><ul><li>total fixed cost (TFC) </li></ul><ul><ul><li>cost of la...
example : yogurt <ul><li>labor = $6/ hour </li></ul><ul><li>TFC = $10/ hour </li></ul>
0  0  10  0  10 1  1  10  6  16 1.6  2  10  9.6  19.6 2  3  10  12  22 4 5 8 9 10 10 24 30 34 40 workers TP TFC TVC TC
Q = output TC TFC 10 TC TVC
Marginal Cost <ul><li>change in TC due to one-unit increase in output (Q) </li></ul>= change in TC change in Q
0  10  0  10 1  10  6  16 2  10  9.6  19.6 3  10  12  22 8 9 10 10 24 30 34 40 MC TP TFC TVC TC 6 3.6 2.4 6
Average Cost (ATC) <ul><li>= TC/Q </li></ul><ul><li>average fixed cost (AFC) </li></ul><ul><ul><li>(TFC/Q) </li></ul></ul>...
0  10  0  10 1  10  6  16 2  10  9.6  19.6 3  10  12  22 8 9 10 10 24 30 34 40 AFC  AVC  AC 10  6  16 5  4.8  9.8  3.33  4...
Q = output AC, MC AFC ATC AVC MC
MC & AC <ul><li>MC intersects AC at its minimum </li></ul><ul><li>MC < AC </li></ul><ul><ul><li>AC is falling </li></ul></...
AC is U-shaped <ul><li>why? </li></ul><ul><li>AFC falls with Q </li></ul><ul><li>AVC falls then rises </li></ul><ul><ul><l...
cost & product curves <ul><li>when MP is at maximum, </li></ul><ul><li>MC is at minimum </li></ul><ul><li>when AP is at ma...
what shifts cost curves? <ul><li>technology </li></ul><ul><ul><li>make more with same inputs </li></ul></ul><ul><ul><li>sh...
<ul><li>changes in factor prices </li></ul><ul><ul><li>increase fixed costs </li></ul></ul><ul><ul><li>-- TFC, AFC shift u...
IV.  LR costs <ul><li>all inputs (and costs) are variable </li></ul><ul><li>what happens if increase plant </li></ul><ul><...
Economies of scale <ul><li>increase inputs 10% </li></ul><ul><ul><li>output increase > 10% </li></ul></ul><ul><ul><li>ATC ...
Diseconomies of scale <ul><li>increase inputs 10% </li></ul><ul><ul><li>output increase < 10% </li></ul></ul><ul><ul><li>A...
Constant returns to scale <ul><li>increase inputs 10% </li></ul><ul><ul><li>output increase = 10% </li></ul></ul><ul><ul><...
LR Average Cost  (LRAC) <ul><li>lowest average cost when all inputs are variable </li></ul><ul><li>SRAC curves from differ...
LRAC Q = output AC ATC1 ATC2 ATC3 ATC4
economies of scale constant returns to  scale diseconomies of scale Q = output AC ATC1 ATC2 ATC3 ATC4
summary: <ul><li>costs = implicit + explicit </li></ul><ul><li>SR, only labor variable </li></ul><ul><li>LR, all inputs va...
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Bec doms ppt on production and costs

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Bec doms ppt on production and costs

  1. 1. Production and Costs <ul><li>economic costs & profits </li></ul><ul><li>short run </li></ul><ul><li>long run </li></ul>
  2. 2. big picture <ul><li>understand behavior of firm </li></ul><ul><li>understand & measure </li></ul><ul><ul><li>production </li></ul></ul><ul><ul><li>costs </li></ul></ul>
  3. 3. I. economic costs & profits <ul><li>firm’s goal: </li></ul><ul><li>maximize profit </li></ul><ul><li>look at factors that affect firm’s decision </li></ul>
  4. 4. economic costs <ul><li>opportunity cost of resources used </li></ul><ul><li>explicit costs </li></ul><ul><ul><li>paid in money </li></ul></ul><ul><ul><li>wages, rent, material, etc. </li></ul></ul><ul><li>implicit costs </li></ul><ul><ul><li>opportunity cost of resources used </li></ul></ul>
  5. 5. example: smoothie shop <ul><li>explicit costs: </li></ul><ul><ul><li>wages </li></ul></ul><ul><ul><li>interest on loan </li></ul></ul><ul><ul><li>rent on store </li></ul></ul><ul><ul><li>fruit, blenders </li></ul></ul>
  6. 6. <ul><li>implicit costs </li></ul><ul><ul><li>forgone interest on funds used to buy capital </li></ul></ul><ul><ul><li>owner’s forgone wages </li></ul></ul><ul><ul><li>owner’s forgone profit from other venture </li></ul></ul>
  7. 7. accounting profit <ul><li>total revenue – explicit costs </li></ul><ul><li>ignores opportunity cost </li></ul>
  8. 8. economic profit <ul><li>includes opp. costs </li></ul><ul><li>= total revenue - total costs </li></ul><ul><li>= (price)(quantity) </li></ul><ul><li>- (explicit + implicit costs) </li></ul>
  9. 9. normal profit <ul><li>occurs when </li></ul><ul><li>amount of accounting profit </li></ul><ul><li>= opportunity costs of resources </li></ul><ul><li>if earning a normal profit, </li></ul><ul><ul><li>economic profit = 0 </li></ul></ul>
  10. 11. Short Run vs. Long Run <ul><li>Short Run (SR) </li></ul><ul><ul><li>time frame where some resources are fixed </li></ul></ul><ul><ul><li>-- plants, equipment </li></ul></ul><ul><ul><li>some inputs variable </li></ul></ul><ul><ul><li>-- labor </li></ul></ul><ul><ul><li>SR decisions are reversible </li></ul></ul>
  11. 12. <ul><li>Long Run (LR) </li></ul><ul><ul><li>time frame where all inputs are variable </li></ul></ul><ul><ul><li>--build a bigger plant </li></ul></ul><ul><ul><li>LR decisions are hard to reverse </li></ul></ul><ul><ul><li>-- cannot easily get rid of capital </li></ul></ul><ul><ul><li>-- sunk cost </li></ul></ul>
  12. 13. II. SR Production <ul><li>measures of output </li></ul><ul><ul><li>total product </li></ul></ul><ul><ul><li>marginal product </li></ul></ul><ul><ul><li>average product </li></ul></ul>
  13. 14. total product (TP) <ul><li>total quantity of good produced </li></ul><ul><li>in a given period </li></ul><ul><li>at first, increases with labor, </li></ul><ul><li>then falls </li></ul>
  14. 15. TP: gal. of smoothies per hour # workers TP 0 1 2 3 4 5 6 7 0 1 3 6 8 9 9 8
  15. 16. TP # workers 5 6 9
  16. 17. marginal product (MP) <ul><li>change in TP due to one more worker </li></ul><ul><li> </li></ul>= change in TP change in labor
  17. 18. At first MP rises with workers <ul><li>add more workers </li></ul><ul><li>greater specialization </li></ul><ul><li>MP of each worker added is larger </li></ul><ul><li>than previous worker </li></ul><ul><li>increasing marginal returns </li></ul>
  18. 19. then, MP falls with more workers <ul><li>keep adding workers </li></ul><ul><li>but same amount of capital </li></ul><ul><li>so eventually get in the way </li></ul><ul><li>MP of more workers smaller than </li></ul><ul><li>MP of previous workers </li></ul><ul><li>decreasing marginal returns </li></ul>
  19. 20. TP, MP: gal. of smoothies # workers TP 0 1 2 3 4 5 6 7 0 1 3 6 8 9 9 8 MP 1 2 3 -1 0 1 2
  20. 21. MP Q = # workers 0 3 3
  21. 22. law of decreasing returns <ul><li>As firm uses more labor </li></ul><ul><ul><li>with capital fixed, </li></ul></ul><ul><ul><li>MP of labor will eventually fall </li></ul></ul>
  22. 23. Average Product (AP) = TP labor = productivity
  23. 24. # workers TP 0 1 2 3 4 5 6 7 0 1 3 6 8 9 9 8 MP AP 1 1.5 2 2 1.8 1.5 1.1 1 2 3 -1 0 1 2
  24. 25. MP # workers AP 0 3 3
  25. 26. MP & AP <ul><li>MP intersects AP at max of AP </li></ul><ul><li>why? </li></ul><ul><li>MP > AP </li></ul><ul><ul><li>AP is rising </li></ul></ul><ul><li>MP < AP </li></ul><ul><ul><li>AP is falling </li></ul></ul>
  26. 27. III. SR cost <ul><li>measure cost 3 ways: </li></ul><ul><ul><li>total cost </li></ul></ul><ul><ul><li>marginal cost </li></ul></ul><ul><ul><li>average cost </li></ul></ul>
  27. 28. Total Cost (TC) <ul><li>cost of all factors used </li></ul><ul><li>total fixed cost (TFC) </li></ul><ul><ul><li>cost of land, capital, etc. </li></ul></ul><ul><ul><li>does not change in SR </li></ul></ul><ul><li>total variable cost (TVC) </li></ul><ul><ul><li>cost of labor </li></ul></ul><ul><ul><li>changes in SR </li></ul></ul><ul><li>TC = TFC + TVC </li></ul>
  28. 29. example : yogurt <ul><li>labor = $6/ hour </li></ul><ul><li>TFC = $10/ hour </li></ul>
  29. 30. 0 0 10 0 10 1 1 10 6 16 1.6 2 10 9.6 19.6 2 3 10 12 22 4 5 8 9 10 10 24 30 34 40 workers TP TFC TVC TC
  30. 31. Q = output TC TFC 10 TC TVC
  31. 32. Marginal Cost <ul><li>change in TC due to one-unit increase in output (Q) </li></ul>= change in TC change in Q
  32. 33. 0 10 0 10 1 10 6 16 2 10 9.6 19.6 3 10 12 22 8 9 10 10 24 30 34 40 MC TP TFC TVC TC 6 3.6 2.4 6
  33. 34. Average Cost (ATC) <ul><li>= TC/Q </li></ul><ul><li>average fixed cost (AFC) </li></ul><ul><ul><li>(TFC/Q) </li></ul></ul><ul><li>average variable cost (AVC) </li></ul><ul><ul><li>(TVC/Q) </li></ul></ul><ul><li>ATC = AFC + AVC </li></ul>
  34. 35. 0 10 0 10 1 10 6 16 2 10 9.6 19.6 3 10 12 22 8 9 10 10 24 30 34 40 AFC AVC AC 10 6 16 5 4.8 9.8 3.33 4 7.33 1.25 3 4.25 1.11 3.33 4.44 TP TFC TVC TC
  35. 36. Q = output AC, MC AFC ATC AVC MC
  36. 37. MC & AC <ul><li>MC intersects AC at its minimum </li></ul><ul><li>MC < AC </li></ul><ul><ul><li>AC is falling </li></ul></ul><ul><li>MC > AC </li></ul><ul><ul><li>AC is rising </li></ul></ul>
  37. 38. AC is U-shaped <ul><li>why? </li></ul><ul><li>AFC falls with Q </li></ul><ul><li>AVC falls then rises </li></ul><ul><ul><li>decreasing marginal returns </li></ul></ul><ul><li>so ATC falls, then rises </li></ul>
  38. 39. cost & product curves <ul><li>when MP is at maximum, </li></ul><ul><li>MC is at minimum </li></ul><ul><li>when AP is at maximum, </li></ul><ul><li>AVC is at minimum </li></ul>
  39. 40. what shifts cost curves? <ul><li>technology </li></ul><ul><ul><li>make more with same inputs </li></ul></ul><ul><ul><li>shifts TP, MP, AP up </li></ul></ul><ul><ul><li>changes ATC curve </li></ul></ul>
  40. 41. <ul><li>changes in factor prices </li></ul><ul><ul><li>increase fixed costs </li></ul></ul><ul><ul><li>-- TFC, AFC shift up </li></ul></ul><ul><ul><li>-- TC shift up </li></ul></ul><ul><ul><li>increase wages (variable) </li></ul></ul><ul><ul><li>-- TVC, AVC, MC shift up </li></ul></ul><ul><ul><li>-- TC shift up </li></ul></ul>
  41. 42. IV. LR costs <ul><li>all inputs (and costs) are variable </li></ul><ul><li>what happens if increase plant </li></ul><ul><li>AND labor by 10%? </li></ul><ul><ul><li>ATC fall? </li></ul></ul><ul><ul><li>ATC rise? </li></ul></ul><ul><ul><li>ATC stay same? </li></ul></ul>
  42. 43. Economies of scale <ul><li>increase inputs 10% </li></ul><ul><ul><li>output increase > 10% </li></ul></ul><ul><ul><li>ATC falls </li></ul></ul><ul><li>why? </li></ul><ul><ul><li>gains from specialization </li></ul></ul><ul><ul><li>-- labor </li></ul></ul><ul><ul><li>-- capital </li></ul></ul>
  43. 44. Diseconomies of scale <ul><li>increase inputs 10% </li></ul><ul><ul><li>output increase < 10% </li></ul></ul><ul><ul><li>ATC rises </li></ul></ul><ul><li>why? </li></ul><ul><ul><li>too hard to control large firm </li></ul></ul>
  44. 45. Constant returns to scale <ul><li>increase inputs 10% </li></ul><ul><ul><li>output increase = 10% </li></ul></ul><ul><ul><li>ATC stays same </li></ul></ul>
  45. 46. LR Average Cost (LRAC) <ul><li>lowest average cost when all inputs are variable </li></ul><ul><li>SRAC curves from different plant sizes </li></ul>
  46. 47. LRAC Q = output AC ATC1 ATC2 ATC3 ATC4
  47. 48. economies of scale constant returns to scale diseconomies of scale Q = output AC ATC1 ATC2 ATC3 ATC4
  48. 49. summary: <ul><li>costs = implicit + explicit </li></ul><ul><li>SR, only labor variable </li></ul><ul><li>LR, all inputs variable </li></ul><ul><li>Production & costs </li></ul><ul><ul><li>total, marginal, average </li></ul></ul><ul><ul><li>fixed, variable </li></ul></ul>

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