Transcript Chapter 9: Public Goods
Chapter 6: Production and Costs
• • •
economic costs & profits short run long run
big picture
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understand behavior of firm understand & measure
production
costs
I. economic costs & profits
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firm’s goal: maximize profit
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look at factors that affect firm’s decision
economic costs
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opportunity cost of resources used explicit costs
paid in money
wages, rent, material, etc.
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implicit costs
opportunity cost of resources used
example: smoothie shop
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explicit costs:
wages
interest on loan
rent on store
fruit, blenders
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implicit costs
forgone interest on funds used to buy capital
owner’s forgone wages
owner’s forgone profit from other venture
accounting profit
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total revenue – explicit costs ignores opportunity cost
economic profit
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includes opp. costs = total revenue - total costs = (price)(quantity) - (explicit + implicit costs)
normal profit
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occurs when amount of accounting profit = opportunity costs of resources
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if earning a normal profit,
economic profit = 0
Short Run vs. Long Run
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Short Run (SR)
time frame where some resources are fixed -- plants, equipment
some inputs variable -- labor
SR decisions are reversible
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Long Run (LR)
time frame where all inputs are variable --build a bigger plant
LR decisions are hard to reverse -- cannot easily get rid of capital -- sunk cost
II. SR Production
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measures of output
total product
marginal product
average product
total product (TP)
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total quantity of good produced in a given period
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at first, increases with labor, then falls
TP: gal. of smoothies per hour # workers 4 5 6 7 0 1 2 3 TP 8 9 9 8 0 1 3 6
TP 9 5 6 # workers
marginal product (MP)
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change in TP due to one more worker = change in TP change in labor
At first MP rises with workers
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add more workers greater specialization MP of each worker added is larger than previous worker
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increasing marginal returns
then, MP falls with more workers
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keep adding workers but same amount of capital so eventually get in the way MP of more workers smaller than MP of previous workers
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decreasing marginal returns
TP, MP: gal. of smoothies # workers 4 5 6 7 0 1 2 3 TP 8 9 9 8 0 1 3 6 1 2 3 2 1 0 -1 MP
MP 3 0 3 Q = # workers
law of decreasing returns
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As firm uses more labor
with capital fixed,
MP of labor will eventually fall
Average Product (AP) = TP labor = productivity
# workers 4 5 6 7 0 1 2 3 TP 8 9 9 8 0 1 3 6 1 2 3 2 1 0 -1 MP AP 1 1.5
2 2 1.8
1.5
1.1
MP 3 0 3 AP # workers
MP & AP
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MP intersects AP at max of AP why?
MP > AP
AP is rising
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MP < AP
AP is falling
III. SR cost
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measure cost 3 ways:
total cost
marginal cost
average cost
Total Cost (TC)
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cost of all factors used total fixed cost (TFC)
cost of land, capital, etc.
does not change in SR
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total variable cost (TVC)
cost of labor
changes in SR
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TC = TFC + TVC
example : yogurt
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labor = $6/ hour TFC = $10/ hour
workers TP TFC TVC TC 0 0 10 0 10 1 1 10 6 16 1.6 2 10 9.6 19.6
2 3 10 12 22 4 5 8 9 10 10 24 30 34 40
TC 10 TC TVC TFC Q = output
Marginal Cost
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change in TC due to one-unit increase in output (Q) = change in TC change in Q
TP TFC TVC TC 0 10 0 10 1 10 6 16 2 10 9.6 19.6
3 10 12 22 MC 6 3.6
2.4
8 9 10 10 24 30 34 40 6
Average Cost (ATC)
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= TC/Q average fixed cost (AFC)
(TFC/Q)
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average variable cost (AVC)
(TVC/Q) ATC = AFC + AVC
TP TFC TVC TC 0 10 0 10 1 10 6 16 2 10 9.6 19.6
3 10 12 22 AFC AVC AC 10 6 16 5 4.8 9.8 3.33 4 7.33
8 9 10 10 24 30 34 40 1.25 3 4.25
1.11 3.33 4.44
AC, MC MC ATC AVC AFC Q = output
MC & AC
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MC intersects AC at its minimum MC < AC
AC is falling
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MC > AC
AC is rising
AC is U-shaped
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why?
AFC falls with Q AVC falls then rises
decreasing marginal returns
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so ATC falls, then rises
cost & product curves
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when MP is at maximum, MC is at minimum
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when AP is at maximum, AVC is at minimum
what shifts cost curves?
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technology
make more with same inputs
shifts TP, MP, AP up
changes ATC curve
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changes in factor prices
increase fixed costs -- TFC, AFC shift up -- TC shift up
increase wages (variable) -- TVC, AVC, MC shift up -- TC shift up
IV. LR costs
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all inputs (and costs) are variable what happens if increase plant AND labor by 10%?
ATC fall?
ATC rise?
ATC stay same?
Economies of scale
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increase inputs 10%
output increase > 10%
ATC falls
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why?
gains from specialization -- labor -- capital
Diseconomies of scale
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increase inputs 10%
output increase < 10%
ATC rises
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why?
too hard to control large firm
Constant returns to scale
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increase inputs 10%
output increase = 10%
ATC stays same
LR Average Cost (LRAC)
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lowest average cost when all inputs are variable SRAC curves from different plant sizes
AC ATC1 ATC2 ATC3 ATC4 LRAC Q = output
AC ATC1 ATC2 ATC3 ATC4 economies of scale constant returns to scale diseconomies of scale Q = output
summary:
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costs = implicit + explicit SR, only labor variable LR, all inputs variable Production & costs
total, marginal, average
fixed, variable