Transcript 20 Costs of Production.ppt

Ch 20.
Costs of Production
A. Economic (opportunity) costs
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Switching from consumers to the behavior of producers.
The measure of the economic costs of any resource needed
to produce a good is the value or worth the resource would
have in its best alternative use (cost = what was given up?).
1.
by
2.
Explicit costs – $ payment
for resources owned
others.
Implicit costs – oppty
costs of using own
resources.
B. Normal profit – cost of doing
business.
C. Economic profit – total
revenue minus economic
costs. Economic = Total - Economic
profit
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Revenue
cost
Economists include as costs of production all the costs (explicit &
implicit, including normal profit) required to attract and retain resources
in a specific line of production.
Normal profit includes the implicit costs of your entrepreneurial talent
(plus foregone rent and foregone wages – payments you would have
otherwise received).
Economic profit is total revenue less economic costs (explicit and
implicit); different terminology than for an Accountant – total revenue
minus explicit costs.
Economic profit vs.
Accounting profit
Economic Profit = Total revenue – Economic cost
Short Run and Long Run
2003
 Short Run: Fixed Plant – period of
time too short to change plant capacity
but long enough to use fixed plant
more or less inexpensively (fixed land/
farm machinery, but can use more
labor/fertilizer) for more output (more
elastic).
 Long Run: Variable Plant – time
period long enough for firms to adjust
their plant sizes & for new firms to
enter (or existing to leave) the industry
(still more elastic).
-- Short-run: At least 1 resource is fixed.
Ex: Can hire a new employee, raise prices, etc.
-- Long-run: All resources are variable.
Ex: Can close a plant.
D. Short-Run Production
Relationships
1. Total Product (TP) – total
quantity or output.
2. Marginal Product (MP) –
extra output from
adding
variable resource
(ie. labor). MP = Δ in TP
Δ in labor input
3.
Average Product (AP) –
output per unit of labor input.
AP =
TP
units of labor
E. Law of Diminishing Returns –
output  grows by smaller %.
-- Law of DR assumes that tech is fixed and therefore techniques
of production don’t change.
-- Successive units of a variable resource (ie labor) are added to
a fixed resource (ie capital or land), beyond some point the extra
(marginal) product that can be attributed to each additional unit of
the variable will decline.
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Column 2 shows the total product (TP), or total output, resulting from adding column 1 and fixed amount of
capital.
Column 3 shows marginal product (MP); change in TP from each additional unit of labor.
AP, or output per labor unit; found by dividing TP by the number of labor units needed to produce it (col. 1)
The Law of Diminishing Returns
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(a) As a variable resource
(labor) is added to fixed
amounts of other resources
(capital/land), the total
product that results will
eventually increase by
diminishing amounts, reach
a maximum, and then
decline.
(b) Marginal product is the
change in total product
associated with each new
unit of labor.
Note that marginal product
intersects average product
at the maximum average
product.
Law of Diminishing Returns
Total Product, TP
Graphical Portrayal
30
TP
20
10
0
Marginal Product, MP
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1
2
3
Increasing
Marginal
20 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
F.
Short-Run Production Costs –
either fixed or variable.
1.
2.
3.
Fixed costs (FC) – don’t vary w/
Δ in output.
Variable costs (VC) – costs that
Δ w/ level of output.
Total cost (TC) – sum of fixed &
variable costs.
TC = TFC + TVC
4.
Average Fixed Cost (AFC)
AFC = TFC
Q
5.
Avg Variable Cost (AVC)
AVC = TVC
Q
6.
Avg Total Cost (ATC)
ATC = TC or TFC + TVC or AFC + AVC
Q
Q
Q
TC is the sum of FC & VC
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Total variable costs (TVC) changes with output.
Total fixed cost (TFC) is independent of the level of output.
The total cost (TC) at any output is the vertical sum of
the fixed cost and variable cost at that output.
Short-Run Production Costs
Total Cost, Fixed and Variable Costs
$1100
TC
1000
900
TVC
800
Costs
700
600
Fixed
Cost
500
400
Total
Cost
300
Variable
Cost
200
100
TFC
0
1
2
3
4
5
6
7
8
9
10
Q
The Average-Cost curves
For most
firms, ATC
declines as
output is
carried to a
certain level,
and then
begins to
rise.
-- The AFC declines continually as output increases.
-- AVC finally falls because of increasing marginal returns but then
rises because of diminishing marginal returns.
-- ATC is the vertical sum of AVC and AFC.
7.
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Table 22.2, column 8.
The MC curve cuts
through the ATC and
AVC curves at their
minimum points.
When MC is below
the ATC, ATC falls.
When MC is above
ATC, ATC rises.
Same with AVC.
Marginal Cost (MC) – extra
(additional) cost of producing 1
more unit of output.
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Refer to the above diagram. At output level Q total variable
cost is:
A) 0BEQ.
B) BCDE.
C) 0CDQ.
D) 0AFQ.
Relationship between productivity curves
and cost curves
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The MC and AVC curves
in (b) are mirror images of
MP and AP curves in (a).
(a) If labor is the only
variable input and its price
(wages) is constant, then if
MP rises, MC is falling;
when MP falls, MC rises.
When AP is rising, AVC
falls; When AP falls, AVC
rises.
Short-Run Production Costs
Average Product and
Marginal Product
Production Curves
Cost Curves
AP
MP
Quantity of Labor
MC
Cost (Dollars)
AVC
Quantity of Output
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In the above diagram the range of diminishing marginal
returns is:
A) 0Q3.
B) 0Q2.
C) Q1Q2.
D) Q1Q3.
G. Long-Run Production Costs
-- Represent
5 possible plant sizes,
Where ATC-1 is the
short-run ATC curve
for the smallest, and
ATC-5 is the largest.
-- Constructing larger
Plants will lower the
min ATC through
plant size 3.
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The Long-Run ATC curve: 5 possible plant sizes.
Made up of segments of the Short-run cost curves (ATC-1,
ATC-2, etc,) of the various sized plants to choose from.
Each point on the planning curve shows the lowest unit cost
attainable for ant output when the firm has had time to make
desired changes in its plant size.
The Long-Run average-total-cost (ATC)
curve: unlimited number of plants
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If the # of possible plant sizes is very large, the L-R/ATC
curve approximates a smooth curve.
Economies of scale, followed by a diseconomies of scale,
causes the curve to be U-shaped.
Long-Run Production Costs
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
Long-Run Production Costs
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
1.
Economies of Scale
a) Labor specialization
b) Managerial spec.
c) Efficient capital
d) Start-up costs
As plant size increases,
a number of factors will
for a time lead to lower
average costs of production
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EofS – reductions in the average total cost of
producing a product as the firm expands the size of
plant (its output) in the long run.
The increase in output from
Q to Q2 causes a decrease
in the average cost of each
unit from c to C1.
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Economies of scale are the cost advantages that a business obtains due to
expansion. They are factors that cause a producer’s average cost per unit to fall as
scale is increased. Economies of scale is a long run concept and refers to
reductions in unit cost as the size of a facility, or scale, increases.
May be utilized by any size firm expanding its scale of operation. The common
ones are purchasing (bulk buying of materials through long-term contracts),
managerial (increasing the specialization of managers), financial (obtaining lowerinterest charges when borrowing from banks and having access to a greater range
of financial instruments), and marketing (spreading the cost of advertising over a
greater range of output in media markets). Each of these factors reduces the long
run average costs (LRAC) of production by shifting the short-run average total cost
(SRATC) curve down and to the right.
Diseconomies of scale are the opposite.
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3.
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Diseconomies of scale
Constant returns to scale
In time the expansion of a firm may lead to diseconomies
and therefore higher ATCs.
DofS: main factor is the difficulty of efficiently controlling and
coordinating a firm’s operations as it becomes a large-scale
producer.
CRtoS: some industries may have a wide range of output
between the output and at which EofS end and the output at
which DofS begin.
CRtoS: there may be a range of CRtoS over which L-R
average cost does not change (q1 to q2 in (a) next slide).
Various possible
L-R/ATC curves
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EofS explains the down-sloping part
of the L-R/ATC curve.
(a) EofS are rapidly obtained as plant
size increases, & diseconomies of
scale are not encountered until a
considerably large scale of output has
been achieved. Thus, L-R/ATC is
constant over a wide range of output.
(b) EofS are extensive, and DofS
occur only at very large outputs. ATC
therefore declines over a broad range
of output.
(c) EofS are exhausted quickly,
followed immediately by DofS.
Minimum ATC thus occurs at a
relatively low output.
H. Minimum Efficient Scale (MES)
I. Natural Monopoly
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MES: lowest level of output at which a firm can minimize L-R
average costs (q1 in (a).
In the extreme, EofS might extend beyond the market’s size,
resulting in a natural monopoly - a relatively rare market
situation in which average TC is minimized when only one
firm produces the particular goods & services.
Long-Run Production Costs
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
Long-Run Production Costs
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
Long-Run Production Costs
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
Applications & Illustrations
(S-R costs, Economies of Scale, &
Minimum Efficiency Scale (MES)
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 costs of insurance & security
Successful start-up firms
Verson stamping machine
Daily newspaper
Aircraft & concrete plants
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Refer to the above diagram. The marginal utility of the third
unit of X is:
A) 5.
B) 4.
C) 2.
D) 1.
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Refer to the above diagram. Total utility:
A) increases so long as additional units of Y are
purchased.
B) becomes negative at 4 units.
C) increases at a diminishing rate, reaches a maximum,
and then declines.
D) is maximized at 2 units.