Transcript Chapter 22

Chapter 22
Supply: The Costs of
Doing Business
Morita’s Cost Curve (Sony Corp.)
Akio Morita, founder of
Sony Corporation, drew
this cost curve for
transistor radios. He saw
that per-unit costs would
fall initially and then rise.
He turned down an order
for 100,000 units because
he thought it would be
risky to increase
production levels that high.
He asked “What if there
were no repeat order the
next year?”
Firms and Production
Review from Chapter 4
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Recall that the terms company, business, and enterprise are
used interchangeably with firm.
Firms can be sole proprietorships, partnerships, or corporations.
They can be national or multinational.
We use the term “firm” to refer to all types of business
organization.
A public company has its shares traded on a stock exchange. A
private company does not have its ownership shares traded on
an exchange. Nonetheless, we can refer to the owners of a
company whether the company is public or private.
Output and Resources
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Businesses pay households income for the use of
resources in production—wages for their labor, rent
for land, and interest for capital.
Households buy goods and services with their
income. The total payments received by businesses
form the firm’s total revenue.
The difference between the firm’s total revenue and
the total payments for resources is profit, which also
flows to households as income.
The Circular Flow
Total Physical Product (TPP)

The total physical product (TPP) curve or
schedule is the relationship between a variable
resource and output, for a given quantity of fixed
resource(s). Sometimes referred to as total
product.

TPP is subject to the law of diminishing marginal
returns: when the amount of at least one of the
resources is fixed, successive increases in the
amount of a variable resource will eventually
yield declining incremental increases in output.
APP and MPP
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The law of diminishing marginal returns shows up more
clearly in the APP and MPP.
The average physical product (APP) is the (average)
output per unit of resource.
APP 

total output
number of mechanics
The marginal physical product (MPP) is the amount of
additional output that is produced when one additional
unit of a resource is used in combination with the same
amount of other resources.
MPP 
total output
change in number of mechanics
Total, Average, and Marginal Product
Mechanics
Total Output
Average
Physical
Product
Marginal
Physical
Product
0
0
--
--
1
100
100
100
2
250
125
150
3
360
120
110
4
440
110
80
5
500
100
60
6
540
90
40
7
550
78.6
10
8
540
675
-10
Total, Average, and
Marginal Product
Marginal and Average
Physical Product
Marginals and
averages always
behave the same
way. When the
marginal is above
the average, the
average is rising.
When the marginal
is below the
average, the
average is falling.
MPP=APP at the
maximum of the
APP.
Total Costs
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The total cost (TC) schedule is plotted on a graph
with output measure on the horizontal axis and total
cost on the vertical.
The total physical product (TPP) curve is plotted with
the units of variable resource on the horizontal axis
and total output on the vertical axis.
The two curves have the same shape, but are mirror
images of one another.
Both are shaped by diminishing marginal returns.
Total Costs
Average Costs

Because the total cost and total physical
product have the same shape, average
physical product and average cost should
also have the same shape.
 Average total cost (ATC) is the cost per unit
of output:
total cost
ATC 
total output
Average Costs
Average Costs
Marginal Costs
Marginal Costs
Cost Schedules and Cost
Curves
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Total fixed costs (TFC) are costs that must be paid
whether the firm produces or not. TFC do not change
with output.
Total variable costs (TVC) are the costs that rise or
fall as production rises or falls.
Total costs (TC) are the sum of total variable and total
fixed costs
Average total cost is sometimes referred to as shortrun average total cost (SRATC) because there are
only fixed resources and fixed costs in the short run.
Over the long run, all resources and costs can be
changed.
Marginal and Average Costs
(1)
Total
Output
(Q)
(2)
Total
Fixed
Costs
(TFC)
(3)
Total
Variable
Costs
(TVC)
(4)
Total
Costs
(TC)
(5)
Average
Fixed
Costs
(AFC)
(6)
Average
Variable
Costs
(AVC)
(7)
Average
Total
Costs
(ATC)
(8)
Marginal
Costs
(MC)
0
$10
$0
$10
1
$10
$10
$20
$10
$10
$20
$10
2
$10
$18
$28
$5
$9
$14
$8
3
$10
$25
$35
$3.33
$8.33
$11.6
$7
4
$10
$30
$40
$2.5
$7.5
$10
$5
5
$10
$35
$45
$2
$7
$9
$5
6
$10
$42
$52
$1.66
$7
$8.66
$7
A
7
$10
$50.6
$60.6
$1.44
$7.2
$8.6
$8.6
B
8
$10
$60
$70
$1.25
$7.5
$8.75
$9.4
9
$10
$80
$90
$1.1
$8.8
$10
$20
Marginal and Average Cost
Curves
Marginal and Average Cost
Curves
Long-Run Cost Curves
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When all resources are changed, we say that the
scale of the firm has changed.
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In the short run, scale is fixed because at least one resource
cannot be changed.
In the long run, the firm can choose any of the
SRATC curves.
The lowest-cost combinations of resources with
which each level of output is produced when all
resources are variable is called the long-run average
total cost (LRATC).
The long run is sometimes referred to as a planning
horizon because over the long run the firm has all
options open to it.
Short-Run and
Long-Run
Average-Cost
Curves
Shape of LRATC
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The LRATC curve gets its shape from
economies and diseconomies of scale.
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If producing each unit of output becomes less
costly as the amount of output increases, we say
there are economies of scale.
If producing each unit of output becomes more
costly as output rises, we say there are
diseconomies of scale.
If unit costs remain constant as output rises, we
say there are constant returns to scale.
Long-Run and
Short-Run Cost Curves (1)
Long-Run and
Short-Run Cost Curves (2)
Minimum Efficient Scale
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Most industries experience both economies
and diseconomies of scale.
 If the long-run average total cost curve
reaches a minimum, the level of output at
which the minimum occurs is called the
minimum efficient scale (MES).
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The MES varies considerably across industries.
Morita’s Problem
and Minimum Efficient Scale