Transcript Chapter 8

Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
8
The Costs of
Production
End Show
8-1
Copyright 2008 The McGraw-Hill Companies
Chapter Objectives
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
End Show
8-2
• Why Do Economic Costs Include
Both Explicit Costs and Implicit
Costs
• How Does the Law of Diminishing
Returns Relate to a Firm’s ShortRun Production Costs
• Learn the Distinctions Between
Fixed and Variable Costs and
Among Total, Average, and
Marginal Costs
• Learn the Link Between a Firm’s
Size and Its Average Costs in the
Long Run
Copyright 2008 The McGraw-Hill Companies
Economic Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
• Economic Cost
• Opportunity Cost
• Explicit Costs
• Implicit Costs
• Normal Profit as a Cost
• Economic or Pure Profit
Economic
Profit
=
Total
Revenue
-
Economic
Cost
End Show
W 8.1
8-3
Copyright 2008 The McGraw-Hill Companies
Profits Compared
Economic Profit Versus Accounting Profits
Key Terms
End Show
8-4
Economics
Economic
Profit
Implicit Costs
(Including a
Normal Profit)
Explicit
Costs
Accounting
Total Revenue
Economic
(Opportunity)
Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Accounting
Profit
Accounting
Costs (Explicit
Costs Only)
Short Run and Long Run
•Short Run: Fixed Plant
•Long Run: Variable Plant
Copyright 2008 The McGraw-Hill Companies
Short-Run Production
Relationships
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
• Total Product (TP)
• Marginal Product (MP)
• Average Product (AP)
Change in Total Product
Marginal Product =
Change in Labor Input
Average Product
Key Terms
=
Total Product
Units of Labor
End Show
W 8.2
8-5
Copyright 2008 The McGraw-Hill Companies
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
End Show
8-6
Law of Diminishing Returns
• Rationale
O 8.1
• Tabular Example
(1)
Units of the
(2)
Variable Resource Total Product
(Labor)
(TP)
0
0
]
10
1
]
25
2
]
45
3
]
60
4
]
70
5
]
75
6
]
75
7
]
70
8
Copyright 2008 The McGraw-Hill Companies
(3)
Marginal Product
(MP),
Change in (2)/
Change in (1)
10
15
20
15
10
5
0
-5
(3)
Average
Product
(AP),
(2)/(1)
Increasing
10.00
Marginal
12.50
Returns
15.00
Diminishing
15.00
Marginal
14.00
Returns
12.50
Negative
10.71
Marginal
Returns
8.75
Key Terms
End Show
8-7
30
TP
20
10
0
Marginal Product, MP
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Total Product, TP
Law of Diminishing Returns
• Graphical Portrayal
1
2
3
Increasing
Marginal
20 Returns
4
5
6
7
9
Negative
Marginal
Returns
Diminishing
Marginal
Returns
10
Copyright 2008 The McGraw-Hill Companies
8
AP
1
2
3
4
5
6
7
8 9
MP
O 8.2
Short-Run Production Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
•Fixed Costs
•Variable Costs
•Total Cost
TC = TFC + TVC
Key Terms
End Show
8-8
Copyright 2008 The McGraw-Hill Companies
Short-Run Production Costs
• Per-Unit or Average Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
End Show
8-9
–Average Fixed Cost (AFC)
–Average Variable Cost
(AVC)
–Average Total Cost (ATC)
–Marginal Cost (MC)
TFC
TVC
AFC =
AVC =
Q
Q
TC
= AFC + AVC
ATC =
Q
Change in TC
MC =
Change in Q
Copyright 2008 The McGraw-Hill Companies
Short-Run Production Costs
Total Cost, Fixed and Variable Costs
$1100
TC
1000
900
TVC
800
700
Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
600
Fixed
Cost
500
400
Total
Cost
300
Variable
Cost
200
100
TFC
Key Terms
0
End Show
8-10
1
Copyright 2008 The McGraw-Hill Companies
2
3
4
5
6
7
8
9
10
Q
Short-Run Production Costs
Average and Marginal Costs
$200
MC
150
Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
AFC
ATC
AVC
100
50
AVC
AFC
Key Terms
0
End Show
1
2
3
4
5
6
7
8
9
10
Q
G 8.1
8-11
Copyright 2008 The McGraw-Hill Companies
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
Short-Run Production Costs
• MC and Marginal Product
• Marginal Decisions
• Relation of MC to AVC and
ATC
• Relationship Between
Productivity Curves and
Cost Curves
• Shifts in Cost Curves
W 8.3
Graphically…
End Show
8-12
Copyright 2008 The McGraw-Hill Companies
Cost Curves
AP
MP
Quantity of Labor
MC
AVC
Cost (Dollars)
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Average Product and
Marginal Product
Short-Run
Production
Costs
Production Curves
Key Terms
End Show
Quantity of Output
8-13
Copyright 2008 The McGraw-Hill Companies
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
End Show
8-14
Long-Run Production Costs
• Firm Size and Costs
• Long-Run Cost Curve
• Economies of Scale
–Labor Specialization
–Managerial Specialization
–Efficient Capital
• Diseconomies of Scale
• Constant Returns to Scale
Copyright 2008 The McGraw-Hill Companies
Long-Run Production Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Average Total Costs
Long-Run ATC Curve
ATC-1
ATC-5
ATC-2
ATC-3
ATC-4
Output
Any Number of Short-Run Optimum
Size Cost Curves Can Be Constructed
Key Terms
End Show
8-15
Copyright 2008 The McGraw-Hill Companies
Long-Run Production Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Average Total Costs
Long-Run ATC Curve
ATC-1
ATC-5
ATC-2
ATC-3
ATC-4
Long-Run
ATC
Output
The Long-Run ATC Curve Just
“Envelopes” the Short Run ATCs
Key Terms
End Show
8-16
Copyright 2008 The McGraw-Hill Companies
Long-Run Production Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Average Total Costs
Long-Run ATC Curve
ATC-1
ATC-5
ATC-2
ATC-3
ATC-4
Long-Run
ATC
Output
The Long-Run ATC Curve Just
“Envelopes” the Short Run ATCs
Key Terms
End Show
8-17
Copyright 2008 The McGraw-Hill Companies
Long-Run Production Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Average Total Costs
Alternative Long-Run ATC Shapes
Constant Returns
To Scale
Economies
Of Scale
Diseconomies
Of Scale
Long-Run
ATC
q1
q2
Output
Long-Run ATC Curve Where Economies
Of Scale Exist
Key Terms
End Show
8-18
Copyright 2008 The McGraw-Hill Companies
Long-Run Production Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Average Total Costs
Alternative Long-Run ATC Shapes
Economies
Of Scale
Diseconomies
Of Scale
Long-Run
ATC
Output
Long-Run ATC Curve Where Costs Are
Lowest Only When Large Numbers Are
Participating
Key Terms
End Show
8-19
Copyright 2008 The McGraw-Hill Companies
Long-Run Production Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Average Total Costs
Alternative Long-Run ATC Shapes
Economies
Of Scale
Diseconomies
Of Scale
Long-Run
ATC
Output
Long-Run ATC Curve Where Economies
Of Scale Exist, are Exhausted Quickly,
And Turn Back Up Substantially
Key Terms
End Show
8-20
Copyright 2008 The McGraw-Hill Companies
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
End Show
8-21
Minimum Efficient Scale and
Industry Structure
• Minimum Efficient Scale
(MES)
• Natural Monopoly
• Applications and Illustrations
O 8.3
– Rising Cost of Insurance and
Security
– Successful Start-Up Firms
– The Verson Stamping Machine
– The Daily Newspaper
– Aircraft and Concrete Plants
Copyright 2008 The McGraw-Hill Companies
Don’t Cry Over Sunk Costs
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
End Show
8-22
• Sunk Costs Irrelevant in
Decision Making
• Once Incurred, They Cannot
Be Recovered
• Compare Marginal Analysis to
Find MC and MB
• Previously Incurred Costs Do
Not Impact the MB=MC
Decision
• Sunk Costs Are Irrelevant!
Copyright 2008 The McGraw-Hill Companies
Key Terms
Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Key Terms
• economic
(opportunity) cost
• explicit costs
• implicit costs
• normal profit
• economic profit
• short run
• long run
• total product (TP)
• marginal product
(MP)
• average product (AP)
• law of diminishing
returns
• fixed costs
End Show
8-23
Copyright 2008 The McGraw-Hill Companies
• variable costs
• total cost
• average fixed cost
(AFC)
• average variable cost
(AVC)
• average total cost
(ATC)
• marginal cost (MC)
• economies of scale
• diseconomies of scale
• constant returns to
scale
• minimum efficient
scale (MES)
• natural monopoly
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Economic
Costs
Profits
Compared
Short-Run
Production
Relationships
Law of
Diminishing
Returns
Short-Run
Production
Costs
Long-Run
Production
Costs
Minimum
Efficient Scale
and Industry
Structure
Last Word
Pure
Competition
Key Terms
End Show
8-24
Copyright 2008 The McGraw-Hill Companies