Transcript Businesses and the Cost of Production

10
Businesses and the Costs of
Production
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Economic Costs
• The payment that must be made to
•
•
LO1
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
Accounting Profit and Normal Profit
• Accounting profit
•
•
LO1
= Revenue – Explicit Costs
Economic profit
= Accounting Profit – Implicit Costs
Economic profit (to summarize)
=Total Revenue – Economic Costs
=Total Revenue – Explicit Costs –
Implicit Costs
Economic Profit
LO1
Implicit costs
(including a
normal profit)
Explicit
costs
Total Revenue
Economic
(Opportunity)
Costs
Economic
profit
Accounting
profit
Accounting
costs (explicit
costs only)
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
Short-Run Production Relationships
• Total Product (TP)
• Marginal Product (MP)
Change in Total Product
Marginal Product =
Change in Labor Input
• Average Product (AP)
Average Product
LO2
=
Total Product
Units of Labor
Total Product, TP
The Law of Diminishing Returns
30
TP
20
10
0
Marginal Product, MP
1
LO2
20
2
3
Increasing
Marginal
Returns
4
5
6
7
8
9
Negative
Marginal
Returns
Diminishing
Marginal
Returns
10
AP
1
2
3
4
5
6
7
8 9
MP
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
Short-Run Production Costs
$1100
TC
1000
900
TVC
800
Costs
700
600
Fixed
Cost
500
400
Total
Cost
300
Variable
Cost
200
100
TFC
0
LO3
1
2
3
4
5
6
7
8
9
10
Q
Per-Unit, or Average, Costs
• Average Fixed Costs
• Average Variable Costs
• Average Total Costs
• Marginal Costs
LO3
AFC = TFC/Q
AVC = TVC/Q
ATC = TC/Q
MC = ΔTC/ΔQ
Per-Unit, or Average, Costs
$200
Costs
150
ATC
AVC
100
AFC
50
AVC
AFC
0
LO3
1
2
3
4
5
6
7
8
9
10
Q
Marginal Cost
$200
MC
Costs
150
ATC
AVC
100
AFC
50
AVC
AFC
0
LO3
1
2
3
4
5
6
7
8
9
10
Q
Average Product and
Marginal Product
MC and Marginal Product
Production Curves
AP
MP
Quantity of Labor
MC
Cost (Dollars)
AVC
Cost Curves
Quantity of Output
LO3
Long-Run Production Costs
• The firm can change all input
•
•
LO4
amounts, including plant size.
All costs are variable in the long run.
Long run ATC
• Different short run ATCs
Average Total Costs
The Long-Run Cost Curve
ATC-1
ATC-5
ATC-2
ATC-3
ATC-4
Output
LO4
Long-Run
ATC
Economies and Diseconomies of Scale
• Economies of scale
• Labor specialization
• Managerial specialization
• Efficient capital
• Other factors
• Constant returns to scale
LO4
Economies and Diseconomies of Scale
• Diseconomies of scale
• Control and coordination problems
• Communication problems
• Worker alienation
• Shirking
LO4
MES and Industry Structure
• Minimum Efficient Scale (MES):
• Lowest level of output where longrun average costs are minimized
• Can determine the structure of the
industry
LO4
Average Total Costs
MES and Industry Structure
Constant Returns
To Scale
Economies
Of Scale
Long-Run
ATC
q1
q2
Output
LO4
Diseconomies
Of Scale
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