macroeconomic mcgrowhill micro ch 7 19e use this one

07
Businesses and the Costs
of Production

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Chapter Objectives
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Key Terms
End Show

8-2

• Why Do Economic Costs Include
Both Explicit Costs and Implicit
Costs
• How Does the Law of Diminishing
Returns Relate to a Firm’s ShortRun Production Costs
• Learn the Distinctions Between
Fixed and Variable Costs and
Among Total, Average, and
Marginal Costs
• Learn the Link Between a Firm’s
Size and Its Average Costs in the
Long Run
Copyright 2008 The McGraw-Hill Companies


Economic Costs
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ

ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

• Economic Cost
• Opportunity Cost
• Explicit Costs
• Implicit Costs
• Normal Profit as a Cost
• Economic or Pure Profit
Economic
Profit

Key Terms
End Show

=

Total
Revenue

-

Economic
Cost
W 8.1

8-3

Copyright 2008 The McGraw-Hill Companies


Economic Costs
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Key Terms
End Show
8-4

• Equal to opportunity costs

• Explicit + implicit costs
• Explicit costs
– Monetary payments

• Implicit costs
– Value of next best use
– Self-owned resources
– Self-employed resources
Copyright 2008 The McGraw-Hill Companies

8-4


Profit
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur

e
Last Word

• Accounting profit
– Total revenue less explicit cost

• Normal profit
– Equal to implicit cost

• Economic or pure profit
– Total revenue less economic
cost

Key Terms
End Show
8-5

Copyright 2008 The McGraw-Hill Companies

8-5


Profits Compared
Economic Profit Versus Accounting Profits
Economics
Economic
Profit
Implicit Costs
(Including a
Normal Profit)

Explicit
Costs

Accounting
Total Revenue

Economic
(Opportunity)
Costs

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Accounting
Profit
Accounting
Costs (Explicit
Costs Only)

Short Run and Long Run
•Short Run: Fixed Plant
•Long Run: Variable Plant

Key Terms
End Show
8-6

Copyright 2008 The McGraw-Hill Companies


SHORT RUN AND LONG RUN
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ

ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Key Terms
End Show
8-7

Accounting:
Short and long run is based
upon annual chronology

Economics:
Short run has fixed plant
capacity size
Long run has variable plant
capacity size
Copyright 2008 The McGraw-Hill Companies


Short and Long Run
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations

hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

• The short run
– Fixed plant capacity
– Variable intensity of plant
use
– Variable output

• The long run
– Variable plant capacity
– Firms enter and exit

Key Terms
End Show
8-8

Copyright 2008 The McGraw-Hill Companies

8-8

Short-Run Production
Relationships

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

• Total Product (TP)
• Marginal Product (MP)
• Average Product (AP)
Change in Total Product
Marginal Product =
Change in Labor Input

Average Product
Key Terms

=

Total Product
Units of Labor

End Show

W 8.2
8-9

Copyright 2008 The McGraw-Hill Companies


Law of Diminishing Returns
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ

ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

• Fixed technology
• Add variable resource to
fixed resource
• Marginal product will
decline
– Beyond some point

• Rationale

Key Terms
End Show
8-10

Copyright 2008 The McGraw-Hill Companies

8-10


Economic Cost
s
Profits Compar
ed
Short-Run Produ

ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Key Terms
End Show
8-11

Law of Diminishing Returns
• Rationale
• Tabular Example
O 8.1

(1)
Units of the
(2)
Variable Resource Total Product
(Labor)
(TP)
0

0
]
10
1
]
25
2
]
45
3
]
60
4
]
70
5
]
75
6
]
75
7
]
70
8
Copyright 2008 The McGraw-Hill Companies

(3)
Marginal Product
(MP),

Change in (2)/
Change in (1)
10
15
20
15
10
5
0
-5

(3)
Average
Product
(AP),
(2)/(1)
Increasing
10.00
Marginal
12.50
Returns
15.00
15.00
Diminishing
Marginal
14.00
Returns
12.50
Negative
10.71

Marginal
8.75
Returns


Key Terms
End Show
8-12

Total Product, TP

30

TP

20
10
0

Marginal Product, MP

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns

Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Law of Diminishing Returns
• Graphical Portrayal

1

2

3

Increasing
Marginal
20 Returns

4

5

6

7

9

Negative
Marginal
Returns

Diminishing
Marginal
Returns

10

Copyright 2008 The McGraw-Hill Companies

8

AP
1

2

3

4

5

6

7

8 9
MP

O 8.2


SHORT-RUN PRODUCTION COSTS
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Fixed Costs
Total Fixed Costs

Average Fixed Costs =

Total Fixed Costs
Quantity

Variable Costs
Total Variable Costs
Average Variable Costs =

Key Terms
End Show
8-13

Copyright 2008 The McGraw-Hill Companies

Total Variable Costs
Quantity


Short-Run Production Costs
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod

uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

• Fixed Costs
• Variable Costs
• Total Cost
TC = TFC + TVC

Key Terms
End Show
8-14

Copyright 2008 The McGraw-Hill Companies


TFC
TVC
AFC =
AVC =
Q
Q
TC
= AFC + AVC
ATC =

Q
Change in TC
MC =
Change in Q

…

– Average Fixed Cost (AFC)
– Average Variable Cost
(AVC)
– Average Total Cost (ATC)
– Marginal Cost (MC)

Gr
ap
hic
all
y

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs

Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Short-Run Production Costs
• Per-Unit or Average Costs

Key Terms
End Show
8-15

Copyright 2008 The McGraw-Hill Companies


SHORT-RUN PRODUCTION COSTS

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod

uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Key Terms
End Show
8-16

Summary of Definitions
Total Fixed Costs =
Total Variable Costs =
Total Costs =
Average Fixed Costs =
Average Variable Costs =
Average Total Costs =
Marginal Cost =
Copyright 2008 The McGraw-Hill Companies

TFC
TVC
TC
AFC
AVC
ATC
MC

Short-Run Production Costs
Total Cost, Fixed and Variable Costs
$1100

TC

1000
900

TVC

800
700

Costs

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ

ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

600

Fixed
Cost

500
400
300

Total
Cost

200

Variable
Cost

100

TFC

Key Terms

0

End Show
8-17

1

Copyright 2008 The McGraw-Hill Companies

2

3

4

5

6

7

8

9

10

Q

Short-Run Production Costs
Average and Marginal Costs
$200

MC

150

Costs

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

AFC

ATC
AVC

100

50

AVC
AFC

Key Terms

0

End Show

1

2

3

4

5

6

7

8

9

10

Q
G 8.1

8-18

Copyright 2008 The McGraw-Hill Companies


Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In

dustry Structur
e
Last Word

Key Terms

Short-Run Production Costs
• MC and Marginal Product
• Marginal Decisions
• Relation of MC to AVC and
ATC
• Relationship Between
Productivity Curves and
Cost Curves
• Shifts in Cost Curves
W 8.3

Graphically…

End Show
8-19

Copyright 2008 The McGraw-Hill Companies


Cost Curves

AP
MP
Quantity of Labor

MC
Cost (Dollars)

Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Average Product and
Marginal Product

Short-Run
Production
Costs
Production Curves

Key Terms
End Show

Quantity of Output
8-20

Copyright 2008 The McGraw-Hill Companies

AVC


Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

Long-Run Production Costs
• Firm Size and Costs
• Long-Run Cost Curve
• Economies of Scale
– Labor Specialization
– Managerial Specialization
– Efficient Capital

• Diseconomies of Scale
• Constant Returns to Scale

Key Terms
End Show
8-21

Copyright 2008 The McGraw-Hill Companies


Long-Run Production Costs
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod

uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

• Choose your plant size
• Minimize ATC
• Different ATC curves
– Short run

• Long run ATC
– Envelope of short run ATC

Key Terms
End Show
8-22

Copyright 2008 The McGraw-Hill Companies

8-22


Long-Run Production Costs
Economic Cost
s
Profits Compar

ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

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

Key Terms
End Show
8-23

Copyright 2008 The McGraw-Hill Companies


Long-Run Production Costs
Economic Cost
s
Profits Compar
ed
Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

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

Key Terms
End Show
8-24

Copyright 2008 The McGraw-Hill Companies


Long-Run Production Costs
Economic Cost
s
Profits Compar
ed

Short-Run Produ
ction Relations
hips
Law of Diminish
ing Returns
Short-Run Prod
uction Costs
Long-Run Produ
ction Costs
Minimum Efficie
nt Scale and In
dustry Structur
e
Last Word

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

Key Terms
End Show
8-25

Copyright 2008 The McGraw-Hill Companies