Transcript CHAPTER 6 THE ORGANIZATION AND COSTS OF PRODUCTION …

Part Two: Microeconomics
of Product Markets
CHAPTER 6
THE ORGANIZATION AND
COSTS OF PRODUCTION
Slides prepared by Dr. Amy Peng, Ryerson University
In this chapter you will learn:
6.1
6.2
6.3
6.4
6.5
The various organizational forms a firm can
take
What are 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
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6
2
The Firm and the Business Sector
Different organizational structures:
1. Plant
2. Firm
3. Industry
• Horizontal combinations
• Vertical combinations
• Conglomerates
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.1
3
The Firm and the Business Sector
•
Legal Forms of Businesses:
1. Sole Proprietorship
2. Partnership
3. Corporation
•
•
Advantages of Corporations
The Principal-Agent Problem
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.1
4
Economic Costs
Opportunity Cost
Explicit Costs
• payments a firm must make
Implicit Costs
• opportunity costs of firm’s own resources
• include normal profits
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.2
5
Normal Profit as a Cost
Total Revenue
Cost of T- shirts
Clerk's salary
Utilities
Total (explicit) costs
Accounting Profit
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$120,000
$40,000
$18,000
$ 5,000
$ 63,000
$ 57,000
Chapter 6.2
6
Normal Profit as a Cost
Total Revenue
Cost of T- shirts
Clerk's salary
Utilities
Total (explicit) costs
Accounting Profit
Forgone interest
Forgone rent
Forgone wages
Normal profit
Total implicit costs
Economic profit
©2007 McGraw-Hill Ryerson Ltd.
$120,000
$40,000
$18,000
$ 5,000
$ 63,000
$ 57,000
$ 1,000
$ 5,000
$22,000
$ 5,000
$ 33,000
$ 24,000
Chapter 6.2
7
Normal Profit as a Cost
• Costs of production include all costs
– explicit
– implicit
– including a normal profit
required to attract and retain factors of
production
Economic profit = total revenue – economic cost
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.2
8
Economic (opportunity) Costs
Figure 6-1
Economic Profit vs. Accounting Profit
Economic
Profits
Implicit costs
(including a
normal profit)
Accounting
Profits
Total
Revenue
Accounting
costs (explicit
costs only)
Explicit
Costs
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.2
9
Short Run and Long Run
• Short Run
– Fixed Plant
• Long Run
– Variable Plant
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.3
10
Short-Run Production Relationships
• Total Product (TP)
– total quantity produced
• Marginal Product (MP)
change in total product
=
change in labour input
• Average Product (AP)
=
©2007 McGraw-Hill Ryerson Ltd.
total product
units of labour
Chapter 6.2
11
Short-Run Production Relationships
Law of Diminishing Returns
• marginal product eventually diminishes
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.3
12
Table 6-1
Total, Marginal, and Average Product
Units of
labour
0
TP
0
1
2
3
4
5
6
7
10
25
45
60
70
75
75
8
70
©2007 McGraw-Hill Ryerson Ltd.
MP
AP
change in total product
MP= change in labour input
Chapter 6.3
13
Total, Marginal, and Average Product
Units of labour
TP
0
0
Increasing marginal
1returns
10
MP
2
25
3
45
Diminishing
4
60
marginal returns
5
70
6
75
7
75
Negative
marginal
10
15
20
15
10
5
0
-5
8 returns 70
©2007 McGraw-Hill Ryerson Ltd.
AP
Chapter 6.3
14
Total, Marginal, and Average Product
Units of
labour
0
1
2
TP
AP=
0
10
25
3
4
5
45
60
70
6
7
75
75
8
70
©2007 McGraw-Hill Ryerson Ltd.
MP
10
15
20
15
10
5
0
-5
totalAP
product
total labour input
10.00
12.50
15.00
15.00
14.00
12.50
10.71
8.75
Chapter 6.3
15
Total Product, TP
75
TP
50
25
0
0increasing
1
2
marginal
returns
3diminishing
4
5
6
7 negative
8
9
marginal
Quantity
of labour
marginal
returns
returns
MP & AP
20
10
AP
0
0
1
2
3
4
5
6
Quantity of labour
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.3
7MP 8
9
Figure 6-2
16
Marginal and Average Values
• 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
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.3
17
Marginal and Average Values
Average value
falling
MP & AP
MP
20>AP
AP
10
0
0
MP
Average
value
1
2
3
4
5
6
rising
Quantity of labour
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.3
MP
<AP
7
8
9
18
Fixed, Variable, and Total Costs
• Fixed Costs
– do not vary with changes in output
• Variable Costs
– change with changes in output
• Total Cost
– sum of fixed and variable costs
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.4
19
Per-Unit, or Average, Costs
TFC
AFC 
Q
TVC
AVC 
Q
TC TFC TVC
ATC 


 AFC  AVC
Q
Q
Q
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.4
20
Marginal Cost
change in TC
MC 
change in Q
• Marginal cost is the extra, or additional,
cost of producing one more unit of output
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.4
21
Q
0
1
2
3
4
5
6
7
8
9
10
TFC TVC
0
100
90
100
100 170
100 240
100 300
100 370
100 450
100 540
100 650
100 780
100 930
©2007 McGraw-Hill Ryerson Ltd.
TC
100
190
AFC AVC ATC
MC
TC=TFC + TVC
270
340
400
470
550
640
750
880
1030
Chapter 6.4
22
Total Cost is the Sum of Fixed Cost and Variable Cost
Figure 6-3
$1,000
$900
$800
Costs
$700
$600
$500
$400
$300
TFC
$200
$100
Q
$0
0
©2007 McGraw-Hill Ryerson Ltd.
2
4
Chapter 6.4
6
8
10
23
Total Cost is the Sum of Fixed Cost and Variable Cost
$1,000
TC
$900
Add vertically to get TC
$800
Costs
$700
TVC
$600
$500
$400
$300
TFC
$200
$100
Q
$0
0
©2007 McGraw-Hill Ryerson Ltd.
2
4
Chapter 6.4
6
8
10
24
Q
0
1
2
3
4
5
6
7
8
9
10
TFC TVC TC AFC AVC ATC MC
AVC=TVC
/100
QATC=TCAFC=TFC
/Q
/Q
100
0
90 190
100 90 190 100
50
85 135
100 170 270
100 240 340 33.33 80 113.33
100
100
100
100
100
100
100
300 400
370 470
450 550
540 640
650 750
780 880
930 1030
©2007 McGraw-Hill Ryerson Ltd.
25
75
100
20
74
94
16.67
75
91.67
14.29
77.14
91.43
12.50
81.25
93.75
11.11
86.67
97.78
10
93
103
Chapter 6.4
25
2.5
Q
TFC TVC TC AFC
MC=AVC
TC / ATC
Q
0
100
0
100
90 190
100 90 190 100
1
50
85 135
2
100 170 270
3
100 240 340 33.33 80 113.33
25
75
100
4
100 300 400
94
20
74
5
100 370 470
MC is
graphed
average
550 at16.67
75 Q 91.67
6 Note:
100
450
7
100 540 640 14.29 77.14 91.43
8
9
10
100
100
100
650 750
780 880
930 1030
©2007 McGraw-Hill Ryerson Ltd.
12.50
11.11
10
Chapter 6.4
81.25
86.67
93
93.75
97.78
MC
90
80
70
60
70
80
90
110
130
150
103
26
AFC, AVC, and ATC
Figure 6-5
$200
AFC continually declines
as fixed cost is spread
over more and more
units
Costs
$150
$100
$50
AFC
$0
Q
10
0
©2007 McGraw-Hill Ryerson Ltd.
2
4
Chapter 6.4
6
8
27
AFC, AVC, and ATC
AVC is U-shaped: it
starts to rise when
AP starts to fall
$200
Costs
$150
AVC
$100
AFC
$50
$0
0
©2007 McGraw-Hill Ryerson Ltd.
2
4
Chapter 6.4
6
8
Q
10
28
AFC, AVC, and ATC
Get ATC by
vertically
summing AFC
and AVC
ATC
$200
Costs
$150
$100
AVC
$50
AFC
$0
Q
10
0
©2007 McGraw-Hill Ryerson Ltd.
2
4
Chapter 6.4
6
8
29
MC, AVC, and ATC
MC cuts ATC and
AVC at minimum
points
$200
ATC
MC
Costs
$150
$100
AVC
$50
AFC
$0
0
©2007 McGraw-Hill Ryerson Ltd.
2
4
Chapter 6.4
6
8
Q
10
30
Average Product and
Marginal Product
Figure 6-6 Productivity Curves and Cost Curves
AP
MP
Labour
Costs (dollars)
MC
AVC
Output
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.4
31
Relation of MC to AVC and ATC
• When MC < current ATC
ATC will fall
• When MC > current ATC
ATC will rise
MC intersects ATC and AVC at minimum
points
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.4
32
Shifts of Cost Curves
Factor Prices
price of fixed input increases...
• AFC and ATC shift up
• AVC and MC unchanged
price of variable input increases...
• AVC, ATC, and MC shift up
• AFC unchanged
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.4
33
Shifts of Cost Curves
Technology
• improved technology
• lower costs
• cost curves shift down
• curve shifts depend on whether
technology affects FC, VC, or both
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.4
34
Long-Run Production Costs
• What will costs look like when the firm
can choose the best plant size for any
given situation?
• For every plant capacity size, there is a
short-run ATC curve
• All such plant capacities can be plotted...
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
35
Figure 6-7
The Long-Run Average-Total-Cost Curve
Average Total Costs
Figure 6-7
ATC-4
ATC-3
ATC-1
ATC-2
ATC-5
Choose the best plant for every output level
These choices determine the LRATC curve
0
10
20
30
40
50
60
70
80
90
Output
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
36
Figure 6-8
The Long-Run Average-Total-Cost Curve
Average Total Costs
Figure 6-8
LRATC
The
number
of possible
plant sizes
is virtually
The
LRATC
curve
just envelops
the short-run
cost
unlimited
Output
curves
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
37
Economies of Scale
–
–
–
–
Labour Specialization
Managerial Specialization
Efficient Capital
Other Factors
• Diseconomies of Scale
• Constant Returns to Scale
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
38
Figure 6-9 Economies and Diseconomies of
Scale
Average Total Costs
Figure 6-9(a)
Economies
of scale
Constant
returns
to scale
Diseconomies
of scale
LRATC
Output
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
39
Minimum Efficient Scale
Figure 6-7
Average Total Costs
ATC-4
ATC-3
ATC-1
0
10
20
30
ATC-2
40
50
ATC-5
60
70
80
MES is the smallest level of output that
Output
minimizes LRATC
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
90
40
Minimum Efficient Scale
Average Total Costs
Figure 6-9(b)
Relatively large MES
natural monopoly
LRATC
Output
MES
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
41
Minimum Efficient Scale
Figure 6-9(c)
Average Total Costs
LRATC
Relatively small MES
competitive industry
MES
Output
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
42
Applications and Illustrations
•
•
•
•
Successful Startup Firms
The Daily Newspaper
The Verson Stamping Machine
Aircraft and Concrete Plants
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6.5
43
Chapter Summary
 6.1 The Firm and the Business Sector
 6.2 Economic Costs
– Opportunity Cost
 6.3 Short-Run Production Relationships
– The Law of Diminishing Return
– TP, AP and MP
 6.4 Short-Run Production Costs
– Fixed Cost, Average Cost, and Marginal Cost
 6.5 Long-Run Production Costs
©2007 McGraw-Hill Ryerson Ltd.
Chapter 6
44