Production and costs

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Production and costs

  1. 1. Production and Costs 1
  2. 2. Explicit Costs and Implicit Costs• Explicit costs = Payments to nonowners of a firm for their resources• Implicit costs = The opportunity costs of using resources owned by the firm 2
  3. 3. Accounting Costs and Economic Costs• Accounting Costs = Explicit Costs• Economic Costs = Total O.C. = Explicit costs + Implicit costs 3
  4. 4. Accounting Profit and Economic Profit• Accounting Profit = Total revenue minus total explicit costs• Economic Profit = Total revenue minus total opportunity costs• Total O.C. = Explicit costs + Implicit costs 4
  5. 5. Computech’s Accounting Versus Economic Profit Item Accounting Profit Economic Profit Total Revenue $500,000 $500,000Less Explicit costs: Wages & salaries $400,000 $400,000 Materials $50,000 $50,000 Interest paid $10,000 $10,000 Other payments $10,000 $10,000Less implicit costs: Foregone salary 0 50,000 Foregone rent 0 10,000Foregone interest 0 5,000 Equals profit $30,000 -$30,000 5 Exhibit 1
  6. 6. Fixed Input and Variable Input• Fixed input - Any resource for which the quantity cannot change during the period of time under consideration• Variable input - Any resource for which the quantity can change during the period of time under consideration 6
  7. 7. Short Run and Long Run• The short run is a time periodduring which a firm has at least onefixed input, such as its factory size.• The long run for a firm is definedas as a period during which allinputs are variable. 7
  8. 8. Production Function• A production function is therelationship between the maximumamounts of outputs a firm can produceand various quantities of inputs.• Holding all other factors of productionconstant, the production function showsthe total output as the amount of oneinput, such as labor, varies. 8
  9. 9. Marginal Product and the Law ofDiminishing Marginal Returns• Marginal product is the change in totaloutput caused by a one-unit change in avariable input, such as the number of workershired.• The law of diminishing returns states thatafter some level of output in the short run,each unit of the variable input yields smallerand smaller marginal product. This range ofdeclining marginal product is the region ofdiminishing returns. 9
  10. 10. 60 Production Function50 Total Output4030 Total Output2010 Quantity of Labor 1 2 3 4 5 6 10
  11. 11. 12 Marginal Product Curve10 Marginal Output 8 6 Law of 4 Diminishing Returns 2 Quantity of Labor 1 2 3 4 5 6 11
  12. 12. Total Fixed Cost, Total Variable Cost and Total Cost• TFC = Costs that do not vary as output varies and that must be paid even if output is zero• TVC = Costs that are zero when output is zero and vary as output varies• TC = The sum of total fixed cost and total variable cost at each level of output• TC = TFC +TVC 12
  13. 13. Short-Run Cost Curves$800$700$600 Cost per unit TFC TC$500 TVC$400$300$200 TFC$100 1 2 3 4 5 6 7 8 9 Q 13
  14. 14. Average Fixed Cost, Average Variable Cost, Average Total Cost and Marginal Cost• AFC = Total fixed cost divided by the quantity of output produced = TFC/Q• AVC = Total variable cost divided by the quantity of output produced = TVC/Q• ATC = Total cost divided by the quantity of output produced = TC/Q = AFC + AVC• MC = The change in total cost when one unit of output is produced = ΔTC/ΔQ = ΔTVC/ΔQ 14
  15. 15. Short-Run Cost Curves$80$70 Cost per unit MC$60 ATC$50$40 AFC AVC$30$20$10 AFC 1 2 3 4 5 6 7 8 9 Q 15
  16. 16. Marginal-Average Rule: When MC < AC, AC falls When MC > AC, AC risesIf MC = AC, AC at minimum 16
  17. 17. Short-Run Cost Curves$80$70 Minimum MC$60 Cost per unit$50 ATC$40 AVC$30$20$10 1 2 3 4 5 6 7 8 9 Q 17
  18. 18. Long-run Average Cost Curve:- The curve that traces the lowest cost per unit at which a firm can produce any level of output when the firm can build any desired plant size 18
  19. 19. Short and Long-run Average Cost Curves$80$70 Short-run average$60 total cost curves$50$40$30$20$10 Long-run average cost curve 2 4 6 8 10 12 14 16 18 Q 19
  20. 20. Economies of Scale:• Those aspects of large scale operation that leads to falling average cost in the long run• Falling portion of the LR AC curve• Factors: 1) Labour economies 2) Capital economies 3) Financial economies 4) Marketing economies 5) Managerial economies 20
  21. 21. Constant Returns to Scale:• A situation in which the long-run average cost curve does notchange as the firm increasesoutput 21
  22. 22. Diseconomies of Scale:• Those aspects of large scale operation that leads to rising average cost in the long run• Rising portion of the LR AC curve• Factors: 1) Labour diseconomies 2) Capital diseconomies 3) Managerial diseconomies 22
  23. 23. Long-run Average Cost Curve$80$70 Constant returns to scale$60 Economies of scale$50$40 Diseconomies of scale$30$20$10 2 4 6 8 10 12 14 16 18 Q 23

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