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# Shortrunandlongruncosts

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### Shortrunandlongruncosts

1. 1. Short Run and Long Run Costs Chapter 5 Pages 178-191
2. 2. What would you need to start a Panera? <ul><li>http://www.panerabread.com/about/franchise/ </li></ul>
3. 3. 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>
4. 4. 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>
5. 5. 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>
6. 6. 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
7. 7. 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>
8. 8. 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>
9. 9. 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>
10. 10. 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>
11. 11. 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>
12. 12. What costs would increase if we wanted to produce one more panini? <ul><li>Variable Costs (such as labor and materials) </li></ul>
13. 13. 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>
14. 14. Costs 46 26 20 230 130 100 5 20     52.5 27.5 25 210 110 100 4 10     66.7 33.33 33.3 200 100 100 3 20     90 40 50 180 80 100 2 30     150 50 100 150 50 100 1 50     - - - 100 0 100 0 MC ATC AVC AFC TC VC FC Q
15. 15. Costs   48 38 10 480 380 100 10 70     45.6 34.44 11.1 410 310 100 9 60     43.8 31.25 12.5 350 250 100 8 50     42.9 28.57 14.3 300 200 100 7 40     43.3 26.67 16.7 260 160 100 6 30     46 26 20 230 130 100 5 MC ATC AVC AFC TC VC FC Q
16. 16. What is happening to TC as Q increases? TC= ATC*Q 150 180 480 Increases!
17. 17. What are total fixed costs in this example? AFC*Q 100*1=100
18. 18. Why are AFC diminishing? Spreading a fixed number out over a larger and larger Q
19. 19. Why is AVC getting closer to ATC? Because ATC = AVC+AFC and AFC is getting close to 0
20. 20. 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!
21. 21. 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
22. 22. How do you know this is the short run? There are fixed costs
23. 23. 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. 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>
25. 25. 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>
26. 26. 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>
27. 27. 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>
28. 28. 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>
29. 29. Why Diseconomies of Scale? <ul><li>Monitoring </li></ul><ul><li>Morale </li></ul><ul><li>Ex: </li></ul>
30. 30. 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>
31. 31. 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>
32. 32. 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>
33. 33. 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
34. 34. In the long run, you can choose any size factory you want...what is the LATC curve? LATC = Minimum of the SATCs! LATC ≤ SATC
35. 35. Where do Economies of Scale exist? LATC Economies of Scale
36. 36. Where do Diseconomies of Scale exist? LATC Diseconomies of Scale
37. 37. 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