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- 1. 1 The Organization and Costsof Production AFC AVC ATC MC
- 2. 2 In this chapteryou will learn The various organizational forms a firm can take The nature of economic costs About a firm’s short-run production relationships About a firm’s short-run production costs The link between a firm’s size and costs in the long run
- 3. 3 Topics to becovered The Business Sector Economic Costs Short-Run Production Relationships Short-Run Production Costs Long-Run Production Costs
- 4. 4 Terminology.... 1- PLANT one location TheBusiness Sector
- 5. 5 Terminology.... 1- PLANT 2- FIRM onebusiness organization with one or more plants The Business Sector NOTES: Vertical Combinations Horizontal Combinations Conglomerates
- 6.
- 7. 7 Terminology.... 1- PLANT 2- FIRMgroup of firms selling similar products 3- INDUSTRY The Business Sector
- 8. 8 Legal Forms ofBusinesses Sole Proprietorship Partnership Corporation Advantages & Disadvantages
- 9. 9 Sole Proprietor Partnership Corporation setup easyeasy more difficult owner autonomy high lower lowest access to capital lowest higher highest access to skills lowest higher highest liability unlimited unlimited limited death of owner dissolves dissolves continues corporations subject to double taxation
- 10. 10 Legal Forms ofBusinesses the principal-agent problem – stock options
- 11. 11 Topics The BusinessSector Economic Costs Short-Run Production Relationships Short-Run Production Costs Long-Run Production Costs
- 12.
- 13. 13 Explicit Costs paymentsa firm must make Implicit Costs opportunity costs of firm’s own resources include normal profits Economic Costs
- 14. 14 Ledger #1 Total Revenue$120,000 Cost of T-shirts $40,000 Clerk's salary $18,000 Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000
- 15. 15 Ledger #2 Total Revenue$120,000 Cost of T-shirts $40,000 Clerk's salary $18,000 Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000 Forgone interest $ 1,000 Forgone rent $ 5,000 Forgone wages $22,000 Normal profit $ 5,000 Total implicit costs $ 33,000 Economic profit $ 24,000
- 16. 16 Economic profit Total revenue Opportunity cost of allinputs Normal Profits Economic or Pure Profits treated as a cost required to attract/retain resources
- 17. Total Revenue Profits to an Economist Profitsto an Accountant 17 Figure 8-1
- 18. Explicit Costs Accounting costs (explicit costs only) Total Revenue Profitsto an Economist Profits to an Accountant 18 Figure 8-1
- 19. Explicit Costs Accounting costs (explicit costs only) Accounting Profits Total Revenue Profitsto an Economist Profits to an Accountant 19 Figure 8-1
- 20. Implicit costs (including a normalprofit) Explicit Costs Accounting costs (explicit costs only) Accounting Profits Economic (opportunity) Costs Total Revenue Profits to an Economist Profits to an Accountant 20 Figure 8-1
- 21. Economic Profits Implicit costs (including a normalprofit) Explicit Costs Accounting costs (explicit costs only) Accounting Profits Economic (opportunity) Costs Total Revenue Profits to an Economist Profits to an Accountant 21 Figure 8-1
- 22. 22 What is the productionfunction? The relationship between the maximum amounts of outputs a firm can produce and various quantities of inputs
- 23. 23 Short-Run and Long-Run Short Run – Fixed Plant Long Run – Variable Plant
- 24. 24 Topics The BusinessSector Economic Costs Short-Run Production Relationships Short-Run Production Costs Long-Run Production Costs
- 25. 25 Short-Run Production Relationships Total Product – total quantity produced Marginal Product Average Product change in total product change in labour input = total product units of labour =
- 26. 26 Short-Run Production Relationships Lawof Diminishing Returns The principle that beyond some point the marginal product decreases as additional units of a variable resource are added to a fixed factor Fixed inputs; it is therefore a short-run concept
- 27. 27 units of labour TP MPAP 0 0 1 10 2 25 3 45 4 60 5 70 6 75 7 75 8 70 change in total product change in labour input MP= Table 8-1
- 28. 28 units of labour TP MPAP 0 0 1 10 2 25 3 45 4 60 5 70 6 75 7 75 8 70 10 15 20 15 10 5 0 -5 increasing marginal returns diminishing marginal returns negative marginal returns Table 8-1
- 29. 29 units of labour TP MPAP 0 0 1 10 2 25 3 45 4 60 5 70 6 75 7 75 8 70 10 15 20 15 10 5 0 -5 10.00 12.50 15.00 15.00 14.00 12.50 10.71 8.75 total product total labour input AP = Table 8-1
- 30. 0 25 50 75 0 1 23 4 5 6 7 8 9 Quantity of labour Total Product, TP 0 10 20 0 1 2 3 4 5 6 7 8 9 Quantity of labour MP & AP AP MP TP increasing marginal returns diminishing marginal returns negative marginal returns 30 Figure 8-2
- 31. 31 Marginal & AverageValues if the average value is rising, the marginal value must be ABOVE the average value if the average value is falling, the marginal value must be BELOW the average value Marginal-Average rule
- 32. 32 Marginal & AverageValues 0 10 20 0 1 2 3 4 5 6 7 8 9 Quantity of labour MP & AP AP MP MP >AP MP <AP average value rising average value falling
- 33. 33 Topics The BusinessSector Economic Costs Short-Run Production Relationships Short-Run Production Costs Long-Run Production Costs
- 34. 34 Fixed Cost • doesnot vary with output Short-Run Production Costs
- 35. 35 Fixed Cost Total fixedcost Short-Run Production Costs
- 36. 36 Fixed Cost Total fixedcost Average fixed cost = Total fixed cost Quantity Short-Run Production Costs
- 37. 37 Fixed Cost Total fixedcost Variable Cost • does vary with output Average fixed cost = Total fixed cost Quantity Short-Run Production Costs
- 38. 38 Fixed Cost Total fixedcost Variable Cost Total variable cost Average fixed cost = Total fixed cost Quantity Short-Run Production Costs
- 39. 39 Fixed Cost Total fixedcost Variable Cost Average variable cost = Total variable cost Quantity Average fixed cost = Total fixed cost Quantity Total variable cost Short-Run Production Costs
- 40. 40 Total Cost Total fixed& variable cost Short-Run Production Costs
- 41. 41 Total Cost Total fixed& variable cost Average total cost = Total cost Quantity Short-Run Production Costs
- 42. 42 Total Cost Total fixed& variable cost Marginal Cost Average total cost = Total cost Quantity Short-Run Production Costs
- 43. 43 Total Cost Total fixed& variable cost Marginal Cost Marginal cost = Change in Total cost Change in Quantity Average total cost = Total cost Quantity Short-Run Production Costs
- 44. 44 Marginal Cost =MC Total Fixed Costs = TFC Total Variable Costs = TVC Average Variable Costs = AVC Total Costs = TC Average Total Costs = ATC Average Fixed Costs = AFC Short-Run Production Costs
- 45. Q TFC TVCTC AFC AVC ATC MC 0 100 1 2 3 4 5 6 7 8 9 10 45 Table 8-2
- 46. Q TFC TVCTC AFC AVC ATC MC 0 100 1 100 2 100 3 100 4 100 5 100 6 100 7 100 8 100 9 100 10 100 46 Table 8-2
- 47. Q TFC TVCTC AFC AVC ATC MC 0 100 0 1 100 90 2 100 170 3 100 240 4 100 300 5 100 370 6 100 450 7 100 540 8 100 650 9 100 780 10 100 930 47 Table 8-2
- 48. Q TFC TVCTC AFC AVC ATC MC 0 100 0 1 100 90 2 100 170 3 100 240 4 100 300 5 100 370 6 100 450 7 100 540 8 100 650 9 100 780 10 100 930 100 190 270 340 400 470 550 640 750 880 1030 TC=TFC + TVC 48 Table 8-2
- 49. Figure 8-3 $0 $100 $200 $300 $400 $500 $600 $700 $800 $900 $1,000 0 24 6 8 10 Q Costs TFC 49
- 50. Figure 8-3 $0 $100 $200 $300 $400 $500 $600 $700 $800 $900 $1,000 0 24 6 8 10 Q Costs TFC TVC 50 add vertically to get TC
- 51. Figure 8-3 $0 $100 $200 $300 $400 $500 $600 $700 $800 $900 $1,000 0 24 6 8 10 Q Costs TFC TVC TC 51
- 52. Q TFC TVCTC AFC AVC ATC MC 0 100 0 1 100 90 2 100 170 3 100 240 4 100 300 5 100 370 6 100 450 7 100 540 8 100 650 9 100 780 10 100 930 100 190 270 340 400 470 550 640 750 880 1030 100 50 33.33 25 20 16.67 14.29 12.50 11.11 10 AFC=TFC / Q 52 Table 8-2
- 53. Q TFC TVCTC AFC AVC ATC MC 0 100 0 1 100 90 2 100 170 3 100 240 4 100 300 5 100 370 6 100 450 7 100 540 8 100 650 9 100 780 10 100 930 100 190 270 340 400 470 550 640 750 880 1030 100 50 33.33 25 20 16.67 14.29 12.50 11.11 10 90 85 80 75 74 75 77.14 81.25 86.67 93 AVC=TVC / Q 53 Table 8-2
- 54. Q TFC TVCTC AFC AVC ATC MC 0 100 0 1 100 90 2 100 170 3 100 240 4 100 300 5 100 370 6 100 450 7 100 540 8 100 650 9 100 780 10 100 930 100 190 270 340 400 470 550 640 750 880 1030 100 50 33.33 25 20 16.67 14.29 12.50 11.11 10 90 85 80 75 74 75 77.14 81.25 86.67 93 190 135 113.33 100 94 91.67 91.43 93.75 97.78 103 ATC=TC / Q 54 Table 8-2
- 55. Q TFC TVCTC AFC AVC ATC MC 0 100 0 1 100 90 2 100 170 3 100 240 4 100 300 5 100 370 6 100 450 7 100 540 8 100 650 9 100 780 10 100 930 100 190 270 340 400 470 550 640 750 880 1030 100 50 33.33 25 20 16.67 14.29 12.50 11.11 10 90 85 80 75 74 75 77.14 81.25 86.67 93 190 135 113.33 100 94 91.67 91.43 93.75 97.78 103 90 80 70 60 70 80 90 110 130 150 MC=TC / Q 55 MC=TC / Q Note: MC is graphed at average Q 2.5 Table 8-2
- 56. Figure 8-4 $0 $50 $100 $150 $200 0 24 6 8 10 Q Costs AFC AFC continually declines as fixed cost is spread over more & more units 56
- 57. Figure 8-4 $0 $50 $100 $150 $200 0 24 6 8 10 Q Costs AFC AVC AVC is U-shaped: AVC starts to rise when AP starts to fall 57 Microeconomics, Chapter 8
- 58. Figure 8-4 $0 $50 $100 $150 $200 0 24 6 8 10 Q Costs AFC AVC get ATC by vertically summing AFC & AVC 58
- 59. Figure 8-4 $0 $50 $100 $150 $200 0 24 6 8 10 Q Costs AFC ATC AVC 59
- 60. Figure 8- 5 $0 $50 $100 $150 $200 02 4 6 8 10 Q Costs AFC ATC MC AVC MC cuts ATC & AVC at minimum points 60
- 61. 61 61 What is the marginal-averagerule? When MC < AC, AC falls When MC > AC, AC rises If, MC = AC, AC at minimum
- 62. Quantity of labour Costs (dollars) Average Product and Marginal Product Quantityof labour Productivity & Cost Curve Relationship, Figure 8-6 62
- 63. Quantity of labour Costs (dollars) Average Product and Marginal Product Quantityof labour MP MC 63 Productivity & Cost Curve Relationship, Figure 8-6
- 64. Quantity of labour Costs (dollars) Average Product and Marginal Product Quantityof labour MP AP MC AVC 64 Productivity & Cost Curve Relationship, Figure 8-6
- 65.
- 66. 66 Cost Curve Shifts resourceprices price of fixed input increases... AFC & ATC shift up AVC & MC unchanged
- 67. $0 $50 $100 $150 $200 0 2 46 8 10 Q Costs AFC ATC MC AVC 67
- 68. $0 $50 $100 $150 $200 0 2 46 8 10 Q Costs AFC ATC MC AVC Fixed costs increase by $25 68
- 69. 69 Cost Curve Shifts resourceprices price of variable input increases... AVC, ATC & MC shift up AFC unchanged
- 70. $0 $50 $100 $150 $200 0 2 46 8 10 Q Costs AFC ATC MC AVC 70
- 71. $0 $50 $100 $150 $200 0 2 46 8 10 Q Costs AFC ATC MC AVC Variable costs increase by 15% 71
- 72. 72 Cost Curve Shifts technology improved technology lower costs cost curves shift down curve shifts depend on whether technology affects FC, VC or both
- 73. 73 Topics The BusinessSector Economic Costs Short-Run Production Relationships Short-Run Production Costs Long-Run Production Costs
- 74. 74 Long-Run Production Costs What will costs look like when the firm can choose the best plant size for any given situation?
- 75. 75 Long-Run Production Costs For every plant capacity size, there is a short-run ATC curve All such plant capacities can be plotted....
- 76. 76 Long-Run Production Costs Figure8-7 0 10 20 30 40 50 60 70 80 90 Output Average Total Costs ATC-1 ATC-2 ATC-3 ATC-4 ATC-5 choose the best plant for every output level
- 77. 77 Long-Run Production Costs Figure8-7 0 10 20 30 40 50 60 70 80 90 Output Average Total Costs ATC-1 ATC-2 ATC-3 ATC-4 ATC-5
- 78. 78 Long-Run Production Costs Figure8-7 0 10 20 30 40 50 60 70 80 90 Output Average Total Costs these choices determine the LRATC curve LRATC
- 79. 79 Long-Run Production Costs Figure8-8 Output Average Total Costs the number of possible plant sizes is virtually unlimited
- 80. 80 Figure 8-8 Output Average Total Costs Long-Run ProductionCosts the LR ATC curve just envelops the short-run cost curves LRATC
- 81.
- 82. 82 Figure 8-9 Output Average Total Costs Long-Run ProductionCosts LRATC Economies of scale
- 83. 83 Figure 8-9 Output Average Total Costs Long-Run ProductionCosts LRATC Constant returns to scale Economies of scale
- 84. 84 Figure 8-9 Output Average Total Costs Long-Run ProductionCosts Economies of scale Constant returns to scale Diseconomies of scale LRATC
- 85. 85 Economies of Scalein Production Increasing Returns to Scale – Labor Specialization – Managerial Specialization – Efficient Capital Constant Returns to Scale Diseconomies of Scale – Chain of command lengthens, and communication becomes more complex.
- 86. 86 Topics Covered TheBusiness Sector Economic Costs Short-Run Production Relationships Short-Run Production Costs Long-Run Production Costs
- 87.