Chap008

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Chap008

  1. 1. Chapter 8 The Costs of ProductionMcGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
  2. 2. Chapter Objectives• Explicit and implicit costs• Law of diminishing returns• Fixed and variable costs• Total, average, and marginal costs• The firm’s size in the long run 8-2
  3. 3. Economic Costs• Opportunity costs• Explicit + implicit costs• Explicit costs –Monetary payments• Implicit costs –Value of next best use –Self-owned resources –Self-employed resources 8-3
  4. 4. Profit• Accounting profit –Total revenue less explicit cost• Economic or pure profit –Total revenue less economic cost 8-4
  5. 5. Profits Compared Economic Accounting Economic Profit Accounting Total Revenue Implicit Costs Profit(Opportunity) (Including a Economic Normal Profit) Costs Accounting Explicit Costs (Explicit Costs Costs Only) 8-5
  6. 6. Short and Long Run• The short run –Fixed plant capacity –Variable intensity of plant use –Variable output• The long run –Variable plant capacity –Firms enter and exit 8-6
  7. 7. Production Relationships• Total product (TP)• Marginal product (MP) Change in Total Product Marginal Product = Change in Labor Input• Average product (AP) Total Product Average Product = Units of Labor 8-7
  8. 8. Law of Diminishing Returns• Fixed technology• Add variable resource to fixed resource• Marginal product will decline –Beyond some point• Rationale 8-8
  9. 9. Law of Diminishing Returns (3) (3) (1) Marginal Product Average Units of the (2) (MP), ProductVariable Resource Total Product Change in (2)/ (AP), (Labor) (TP) Change in (1) (2)/(1) 0 0 - 1 10 ] 10 Increasing 10.00 2 25 ] 15 Marginal Returns 12.50 3 45 ] 4 60 ] 5 70 ] 75 ] 6 ] 7 75 ] 8 70 8-9
  10. 10. Law of Diminishing Returns (3) (3) (1) Marginal Product Average Units of the (2) (MP), ProductVariable Resource Total Product Change in (2)/ (AP), (Labor) (TP) Change in (1) (2)/(1) 0 0 - 1 10 ] 10 Increasing 10.00 2 25 ] 15 Marginal Returns 12.50 3 45 ] 20 15.00 4 60 ] 15 Diminishing 15.00 5 70 ] 10 Marginal 14.00 75 ] 5 Returns 12.50 6 ] 0 Negative 7 75 10.71 ] -5 Marginal Returns 8 70 8.75 8-10
  11. 11. Law of Diminishing Returns Total Product, TP 30 TP 20 10 0 1 2 3 4 5 6 7 8 9 Marginal Product, MP Increasing Diminishing Negative Marginal Marginal Marginal 20 Returns Returns Returns 10 AP 1 2 3 4 5 6 7 8 9 MP 8-11
  12. 12. Law of Diminishing Returns
  13. 13. Short-Run Production Costs• Fixed Costs –Do not vary with output• Variable Costs –Materials, most labor• Total Cost –TC = TFC + TVC 8-13
  14. 14. Per-Unit Production Costs• Average fixed cost AFC = TFC/Q• Average variable cost AVC = TVC/Q• Average total cost ATC = TC/Q = TFC/Q + TVC/Q ATC = AFC+AVC• Marginal cost MC = change in TC/change in Q 8-14
  15. 15. Cost for Individual Firm
  16. 16. Short-Run Production Costs $1100 1000 TC 900 TVC 800 700 Costs 600 Fixed 500 Cost 400 300 Total Variable Cost Cost 200 100 TFC 0 1 2 3 4 5 6 7 8 9 10 Q 8-16
  17. 17. Short-Run Production Costs $200 MC Costs 150 ATC 100 AVC AFC 50 AVC AFC 0 1 2 3 4 5 6 7 8 9 10 Q 8-17
  18. 18. Production Relationships• Marginal cost and diminishing returns• Marginal cost and marginal product• Marginal cost and average variable cost• Marginal cost and average total cost• Production curves and cost curves• Shifts in cost curves 8-18
  19. 19. Graphical Relationships Production CurvesAverage Product and Marginal Product AP MP Quantity of Labor MC AVC Cost (Dollars) Cost Curves Quantity of Output 8-19
  20. 20. Long-Run Production Costs• Choose your plant size• Minimize ATC• Different ATC curves –Short run• Long run ATC –Envelope of short run ATC 8-20
  21. 21. Long-Run ATC CurveAverage Total Costs ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Output Any number of short-run optimum size cost curves can be constructed 8-21
  22. 22. Long-Run ATC CurveAverage Total Costs ATC-1 ATC-5 ATC-2 Long-Run ATC-3 ATC-4 ATC Output The long-run ATC curve just “envelopes” the short run ATCs 8-22
  23. 23. Long Run Production Cost• Economies of Scale –Labor specialization –Managerial specialization –Efficient capital• Diseconomies of Scale• Constant Returns to Scale 8-23
  24. 24. Long-Run ATC Shapes Economies Constant Returns DiseconomiesAverage Total Costs Of Scale To Scale Of Scale Long-Run ATC q1 q2 Output Long-run ATC curve where economies of scale exist 8-24
  25. 25. Long-Run ATC Shapes Economies DiseconomiesAverage Total Costs Of Scale Of Scale Long-Run ATC Output Long-run ATC curve where costs are lowest only when large numbers are participating 8-25
  26. 26. Long-Run ATC Shapes Economies DiseconomiesAverage Total Costs Of Scale Of Scale Long-Run ATC Output Long-run ATC curve where economies of scale exist, are exhausted quickly, and turn back up substantially 8-26
  27. 27. Key Terms• economic (opportunity) • variable costs cost • total cost• explicit costs • average fixed cost (AFC)• implicit costs • average variable cost• normal profit (AVC)• economic profit • average total cost (ATC)• short run • marginal cost (MC)• long run • economies of scale• total product (TP) • diseconomies of scale• marginal product (MP) • constant returns to scale• average product (AP) • minimum efficient scale• law of diminishing returns (MES)• fixed costs • natural monopoly 8-27
  28. 28. Next Chapter Preview… Pure Competition 8-28

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