Chapter 9: Public Goods

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Transcript Chapter 9: Public Goods

Chapter 6: Production and Costs

• • •

economic costs & profits short run long run

big picture

• •

understand behavior of firm understand & measure

production

costs

I. economic costs & profits

firm’s goal: maximize profit

look at factors that affect firm’s decision

economic costs

• •

opportunity cost of resources used explicit costs

paid in money

wages, rent, material, etc.

implicit costs

opportunity cost of resources used

example: smoothie shop

explicit costs:

wages

interest on loan

rent on store

fruit, blenders

implicit costs

forgone interest on funds used to buy capital

owner’s forgone wages

owner’s forgone profit from other venture

accounting profit

• •

total revenue – explicit costs ignores opportunity cost

economic profit

includes opp. costs = total revenue - total costs = (price)(quantity) - (explicit + implicit costs)

normal profit

• •

occurs when amount of accounting profit = opportunity costs of resources

if earning a normal profit,

economic profit = 0

Short Run vs. Long Run

Short Run (SR)

time frame where some resources are fixed -- plants, equipment

some inputs variable -- labor

SR decisions are reversible

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

measures of output

total product

marginal product

average product

total product (TP)

total quantity of good produced in a given period

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)

change in TP due to one more worker = change in TP change in labor

At first MP rises with workers

• • •

add more workers greater specialization MP of each worker added is larger than previous worker

increasing marginal returns

then, MP falls with more workers

• • • •

keep adding workers but same amount of capital so eventually get in the way MP of more workers smaller than MP of previous workers

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

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

MP < AP

AP is falling

III. SR cost

measure cost 3 ways:

total cost

marginal cost

average cost

Total Cost (TC)

• •

cost of all factors used total fixed cost (TFC)

cost of land, capital, etc.

does not change in SR

total variable cost (TVC)

cost of labor

changes in SR

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

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)

• • •

= TC/Q average fixed cost (AFC)

(TFC/Q)

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

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

so ATC falls, then rises

cost & product curves

when MP is at maximum, MC is at minimum

when AP is at maximum, AVC is at minimum

what shifts cost curves?

technology

make more with same inputs

shifts TP, MP, AP up

changes ATC curve

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

increase inputs 10%

output increase > 10%

ATC falls

why?

gains from specialization -- labor -- capital

Diseconomies of scale

increase inputs 10%

output increase < 10%

ATC rises

why?

too hard to control large firm

Constant returns to scale

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