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Chap007 (1)

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Chap007 (1)

  1. 1. Businesses and the Costs of Production 07 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
  2. 2. Economic Costs • The payment that must be made to obtain and retain the services of a resource • Explicit Costs •Monetary payments • Implicit Costs •Value of next best use •Self-owned resources •Includes normal profit LO1 7-2
  3. 3. Accounting Profit and Normal Profit • Accounting profit = Revenue – Explicit Costs • Economic profit = Accounting Profit – Implicit Costs • Economic profit (to summarize) =Total Revenue – Economic Costs =Total Revenue – Explicit Costs – Implicit Costs LO1 7-3
  4. 4. Economic Profit LO1 Explicit costs Accounting costs (explicit costs only) Implicit costs (including a normal profit) Economic profit Accounting profit Economic (Opportunity) Costs TotalRevenue 7-4
  5. 5. Short Run and Long Run • Short Run •Some variable inputs •Fixed plant • Long Run •All inputs are variable •Variable plant •Firms enter and exit LO1 7-5
  6. 6. Short-Run Production Relationships • Total Product (TP) • Marginal Product (MP) • Average Product (AP) LO2 Marginal Product Change in Total Product Change in Labor Input= Average Product Total Product Units of Labor = 7-6
  7. 7. The Law of Diminishing Returns LO2 TP MP AP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 1 2 3 4 5 6 7 8 9 0 10 20 30 TotalProduct,TP 1 2 3 4 5 6 7 8 9 20 10 MarginalProduct,MP 7-7
  8. 8. Short-Run Production Costs • Fixed Costs (TFC) •Costs do not vary with output • Variable Costs (TVC) •Costs vary with output • Total Costs (TC) •Sum of TFC and TVC •TC = TFC + TVC LO3 7-8
  9. 9. Short-Run Production Costs LO3 Costs 1 2 3 4 5 6 7 8 9 100 Q 100 200 300 400 500 600 700 800 900 1000 $1100 TFC TC TVC Total Cost Variable Cost Fixed Cost 7-9
  10. 10. Per-Unit, or Average, Costs • Average Fixed Costs AFC = TFC/Q • Average Variable Costs AVC = TVC/Q • Average Total Costs ATC = TC/Q • Marginal Costs MC = ΔTC/ΔQ LO3 7-10
  11. 11. Per-Unit, or Average, Costs LO3 Costs 1 2 3 4 5 6 7 8 9 100 Q 50 100 150 $200 AFC ATC AVC AVC AFC 7-11
  12. 12. Marginal Cost LO3 Costs 1 2 3 4 5 6 7 8 9 100 Q 50 100 150 $200 AFC MC ATC AVC AVC AFC 7-12
  13. 13. MC and Marginal Product LO3 MP AP MC AVC Quantity of Output Quantity of Labor Production Curves Cost Curves 7-13
  14. 14. Long-Run Production Costs • The firm can change all input amounts, including plant size. • All costs are variable in the long run. • Long run ATC •Different short run ATCs LO4 7-14
  15. 15. The Long-Run Cost Curve LO4 Long-Run ATC AverageTotalCosts ATC-1 ATC-2 ATC-3 ATC-4 ATC-5 Output 7-15
  16. 16. Economies and Diseconomies of Scale • Economies of scale •Labor specialization •Managerial specialization •Efficient capital •Other factors • Constant returns to scale LO4 7-16
  17. 17. Economies and Diseconomies of Scale • Diseconomies of scale •Control and coordination problems •Communication problems •Worker alienation •Shirking LO4 7-17
  18. 18. MES and Industry Structure • Minimum Efficient Scale (MES): •Lowest level of output where long- run average costs are minimized •Can determine the structure of the industry LO4 7-18
  19. 19. MES and Industry Structure LO4 Output AverageTotalCosts Long-Run ATC Economies Of Scale Constant Returns To Scale Diseconomies Of Scale q1 q2 7-19
  20. 20. Don’t Cry Over Sunk Costs • Sunk costs •Costs have already been incurred and thus are irrecoverable • Rule: Do not engage in any activity where MB<MC • Rule: Ignore sunk costs •They are irrecoverable 7-20

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