Transcript Chapter 23 The Firm: Cost and Output Determination

Chapter 23
The Firm:
Cost and Output
Determination
Introduction
Freight dispatchers use real-time
information transmitted by computers to
monitor the positions of locomotives and
rolling stock along the nation’s railways.
In what respect does the availability of
information affect the operating costs of
any business?
Slide 23-2
Learning Objectives
 Discuss the difference between the
short run and the long run from the
perspective of a firm
 Understand why the marginal physical
product of labor eventually declines as
more units of labor are employed
Slide 23-3
Learning Objectives
 Explain the short-run cost curves faced by a
typical firm
 Explain the long-run cost curves faced by a
typical firm
 Identify situations of economies and
diseconomies of scale and define a firm’s
minimum efficient scale
Slide 23-4
Chapter Outline
 Short Run versus Long Run
 Relationship Between Output and Inputs
 Diminishing Marginal Returns
 Short-Run Costs to the Firm
Slide 23-5
Chapter Outline
 The Relationship Between Diminishing
Marginal Returns and Cost Curves
 Long-Run Cost Curves
 Why the Long-Run Average Cost Curve is
U-Shaped
 Minimum Efficient Scale
Slide 23-6
Did You Know That...
 As electric utilities have increased their
generating capacity over the past ten
years, they also have lowered the
average cost of producing power?
 In some other industries, a higher
productive capacity is associated with
a higher average cost?
Slide 23-7
Short Run versus Long Run
 Short Run
– A time period when at least one input,
such as plant size, cannot be changed
– Plant Size
• The physical size of the factories that a firm
owns and operates to produce its output
Slide 23-8
Short Run versus Long Run
 Long Run
– The time period in which all factors of
production can be varied
Slide 23-9
Short Run versus Long Run
 Short run and long run are terms that
apply to planning decisions made by
managers. The firm always operates
in the short run in the sense that
decisions can only be made in the
present.
 But some of these decisions result in a
long-term commitment of resources.
Slide 23-10
The Relationship
Between Output and Inputs
Output/time period = some function of capital and labor inputs
or
Q = ƒ(K,L)
Q = output/time period
K = capital
L = labor
Slide 23-11
The Relationship
Between Output and Inputs
 Production
– Any activity that results in the conversion
of resources into products that can be
used in consumption
Slide 23-12
The Relationship
Between Output and Inputs
 Production Function
– The relationship between inputs and
output
– A technological, not an economic,
relationship
– The relationship between inputs and
maximum physical output
Slide 23-13
Example:
The Optimal Load Size for Trucks
 Procter & Gamble is a consumer products
company that supplies soap and personal
care products to retailers.
 Using inventory-tracking software, the
company found that it could make more
efficient use of all inputs if it dispatched
trucks from its manufacturing facilities with
less than full loads.
Slide 23-14
Example:
The Optimal Load Size for Trucks
 The efficiency resulted from the fact that
workers who loaded the trucks were more
productive and that total fuel consumption was
less when trucks were only partially loaded.
 The inventory-tracking software allowed the
company to identify parts of its production
function that would have been difficult to
determine through casual observation.
Slide 23-15
Diminishing Marginal Returns
 Law of Diminishing (Marginal) Returns
– The observation that after some point,
successive equal-sized increases in a
variable factor of production, such as
labor, added to fixed factors of production,
will result in smaller increases in output
Slide 23-16
The Relationship
Between Output and Inputs
 Average Physical Product
– Total product divided by the variable input
Slide 23-17
The Relationship
Between Output and Inputs
 Marginal Physical Product
– The physical output that is due to the
addition of one more unit of a variable
factor of production
– The change in total product occurring
when a variable input is increased and all
other inputs are held constant
– Also called marginal product or marginal
return
Slide 23-18
Diminishing Returns, the Production Function,
and Marginal Product: A Hypothetical Case
Figure 23-1, Panel (a)
Slide 23-19
Diminishing Returns, the Production Function,
and Marginal Product: A Hypothetical Case
Figure 23-1, Panel (b)
Slide 23-20
Diminishing Returns, the Production Function,
and Marginal Product: A Hypothetical Case
Figure 23-1, Panel (c)
Slide 23-21
An Example of the Law of
Diminishing Returns
 Production of computer printers
– With a fixed amount of factory space,
assembly equipment, and quality control
diagnostic software, more workers can
add to total output.
– But the additional increments of quantity
produced will lessen as more labor is
added.
Slide 23-22
An Example of the Law of
Diminishing Returns
 Beyond a certain point, as more
workers as added, they will have to
assemble the printers manually.
 The marginal physical product of labor,
while remaining positive, will decline.
Slide 23-23
Short-Run Costs to the Firm
 Total Costs
– The sum of total fixed costs and total variable
costs
 Fixed Costs
– Costs that do not vary with output
 Variable Costs
– Costs that vary with the rate of production
Total costs (TC) = TFC + TVC
Slide 23-24
Cost of Production: An Example
Figure 23-2, Panel (a)
Slide 23-25
Cost of Production: An Example
Panel (b)
Total costs (dollars per day)
60
Total costs
50
40
30
Total variable
costs
20
10
0
Figure 23-2, Panel (b)
Total fixed
costs
1
2 3 4 5 6 7 8 9 10
Output (recordable DVDs per day)
11
Slide 23-26
Short-Run Costs to the Firm
 Average Total Costs (ATC)
total costs (TC)
Average total costs (ATC) =
output (Q)
Slide 23-27
Short-Run Costs to the Firm
 Average Variable Costs (AVC)
Average variable costs (AVC) =
total variable costs (TVC)
output (Q)
Slide 23-28
Short-Run Costs to the Firm
 Average Fixed Costs (AFC)
Average fixed costs (AFC) =
total fixed costs (TFC)
output (Q)
Slide 23-29
Short-Run Costs to the Firm
 Marginal Cost
– The change in total costs due to a oneunit change in production rate
Marginal costs (MC) =
change in total cost
change in output
Slide 23-30
Short-Run Costs to the Firm
 What do you think?
– Is there a predictable relationship
between the production function and AVC,
ATC, and MC?
Slide 23-31
Short-Run Costs to the Firm
 Answer
– As long as marginal physical product
rises, marginal cost will fall, and when
marginal physical product starts to fall
(after reaching the point of diminishing
marginal returns), marginal cost will begin
to rise.
Slide 23-32
E-Commerce Example:
Internet Package Tracking
 The marginal cost incurred by FedEx in
delivering one additional package
includes the transportation expense
and also the cost of providing
information to senders or recipients
who inquire about the status of the
shipment.
Slide 23-33
E-Commerce Example:
Internet Package Tracking
 As the internet has made it easier to
provide this information for customers,
FedEx has experienced a downward
shift of its marginal cost curve.
Slide 23-34
The Relationship Between
Average and Marginal Costs
 When marginal cost is less than
average variable cost, then average
variable cost will decline.
 When marginal cost exceeds average
variable cost, then average variable
cost will increase.
Slide 23-35
The Relationship Between
Average and Marginal Costs
 It is also true that the direction of
change in average total cost will be
determined by whether marginal cost
exceeds the current average.
Slide 23-36
The Relationship Between Diminishing
Marginal Returns and Cost Curves
 Firms’ short-run cost curves are a
reflection of the law of diminishing
marginal returns.
 Given any constant price of the
variable input, marginal costs decline
as long as the marginal product of the
variable resource is rising.
Slide 23-37
The Relationship Between Diminishing
Marginal Returns and Cost Curves
 At the point at which diminishing
marginal returns begin, marginal costs
begin to rise as the marginal product of
the variable input begins to decline.
Slide 23-38
The Relationship Between Diminishing
Marginal Returns and Cost Curves
 If the wage rate is constant, then the
labor cost associated with each
additional unit of output will decline as
long as the marginal physical product
of labor increases.
Slide 23-39
Long-Run Cost Curves
 Planning Horizon
– The long run, during which all inputs are
variable
Slide 23-40
Preferable Plant Size
and the Long-Run Average Cost Curve
Panel (b)
SAC1
C2
C4
SAC2
C1
C3
SAC3
Q1
Q2
Output per Time Period
Figure 23-4, Panels (a) and (b)
Average Cost (dollars per unit of output)
Average Cost (dollars per unit of output)
Panel (a)
SAC8
SAC1
SAC7
SAC2
SAC6
SAC3
SAC5
SAC4
LAC
Output per Time Period
Slide 23-41
Long-Run Cost Curves
 Long-Run Average Cost Curve
– The locus of points representing the
minimum unit cost of producing any given
rate of output, given current technology
and resource prices
Slide 23-42
Long-Run Cost Curves
 Observation
– Only at minimum long-run average cost
curve is short-run average cost curve
tangent to long-run average cost curve
 What do you think?
– Why is the long-run average cost curve
U-shaped?
Slide 23-43
Why the Long-Run Average
Cost Curve is U-Shaped
 Economies of Scale
– Decreases in long-run average costs
resulting from increases in output
• These economies of scale do not persist
indefinitely, however.
• Once long-run average costs rise, the curve
begins to slope upwards.
Slide 23-44
Why the Long-Run Average
Cost Curve is U-Shaped
 Reasons for economies of scale
– Specialization
– Dimensional factor
– Improved productive equipment
Slide 23-45
Why the Long-Run Average
Cost Curve is U-Shaped
 Explaining diseconomies of scale
– Limits to the efficient functioning of
management
– Coordination and communication is more
of a challenge as firm size increases
Slide 23-46
International Example:
Reducing Firm Size to Reduce Costs
 In the past decade, the Chinese government
has sold many of the companies that were
originally state-financed endeavors.
 Although these firms received subsidies
when they were government-sponsored
enterprises, they had to be self-financing
once they were in the hands of private
investors.
Slide 23-47
International Example:
Reducing Firm Size to Reduce Costs
 In many instances, the private owners
chose to reduce the scale of
operations.
 This has resulted in lower long-run
average costs, and the firms can
expect to keep operating without
subsidies.
Slide 23-48
Minimum Efficient Scale
 Minimum Efficient Scale (MES)
– The lowest rate of output per unit time at
which long-run average costs for a
particular firm are at a minimum
Slide 23-49
Minimum Efficient Scale
 Small MES relative to industry demand:
– There is room for many efficient firms
– High degree of competition
 Large MES relative to industry demand:
– Room for only a small number of efficient firms
– Small degree of competition
Slide 23-50
Long-Run Average Costs
(dollars per unit)
Minimum Efficient Scale
LAC
B
A
0
10
1,000
Output per Time Period
Figure 23-6
Slide 23-51
Example:
Plant Size for Doughnuts
 The Krispy Kreme Doughnut empire is
a chain of stores, each one equipped
with machinery designed to bake tens
of thousands of doughnuts each day.
 As the chain has expanded its number
of locations, some stores are
competing against one another.
Slide 23-52
Example:
Plant Size for Doughnuts
 The result is that, in some locations, many of
the doughnuts produced are thrown out after
aging for more than a day.
 This raises the average cost of each
doughnut sold.
 The expansion of the chain has led to an
increase in long-run average costs,
suggesting that the company has surpassed
the size of its minimum efficient scale.
Slide 23-53
Issues and Applications: Railroad
Locomotives as a High-Tech Gadget?
 With computers doing much of the
work of monitoring locomotive engines
and switching trains between tracks,
the marginal product of labor in the
railroad industry has been enhanced.
 As economic theory would predict, this
has resulted in lower average costs.
Slide 23-54
Summary Discussion
of Learning Objectives
 The short run versus the long run from
a firm’s perspective
– Short run: a period in which at least one
input is fixed
– Long run: a period in which all inputs are
available
Slide 23-55
Summary Discussion
of Learning Objectives
 The law of diminishing marginal returns
– As more units of a variable input are employed
with a fixed input, marginal physical product
eventually begins to decline
 A firm’s short-run cost curves
–
–
–
–
Fixed and average fixed cost
Variable and average variable cost
Total and average total cost
Marginal cost
Slide 23-56
Summary Discussion
of Learning Objectives
 A firm’s long-run cost curve
– Planning horizon
– All inputs are variable including plant size
 Economies and diseconomies of scale
and a firm’s minimum efficient scale
Slide 23-57
End of
Chapter 23
The Firm:
Cost and Output
Determination