micro economics chapter 09 1
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9
Businesses and the Costs
of Production
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
•
•
•
LO1
Economic Costs
The payment that must be made to
obtain and retain the services of a
resource
Explicit Costs
• Monetary payments, often uses check
Implicit Costs
• Value of next best use
• What the firm gives up
• Includes normal profit
•
•
LO1
Economic Costs
Normal profit
• Minimum payment required to remain
engaged in current enterprise.
Economic profit means firm is earning a
normal profit.
Accounting Profit and Normal
Profit
• Accounting profit
•
LO1
= Revenue – Explicit Costs
Economic profit
= Revenue – Explicit - Implicit Costs
Short Run and Long Run
• Short Run
• Some variable inputs
• Fixed plant
• Long Run
• All inputs are variable
• Variable plant
• Firms enter and exit
LO1
Short-Run Production
Relationships
• Total Product (TP)
• Marginal Product (MP)
Change in Total Product
Marginal Product =
Change in Labor Input
• Average Product (AP)
Average Product
LO2
=
Total Product
Units of Labor
Law of Diminishing Marginal
Returns
• Resources are of equal quality
• Technology fixed
• Variable resources are added to fixed
•
LO2
resources
At some point, marginal product will
fall
The Law of Diminishing Returns
Table 7.1 Total, Marginal, and Average Product: The Law of Diminishing Returns
LO2
(1)
Units of the
Variable
Resource
(Labor)
(3)
Marginal
Product (MP)
Change in (2)/
Change in (1)
(2)
Total Product
(TP)
0
0
1
10
10
2
25
15
3
45
20
4
60
15
5
70
10
6
75
5
7
75
0
8
70
-5
(4)
Average Product
(AP),
(2)/(1)
Increasing
marginal
returns
10.00
12.50
15.00
15.00
Diminishing
marginal
returns
14.00
12.50
10.71
Negative
marginal
returns
8.75
Short-Run Production Costs
• Fixed Costs (TFC)
• Costs do not vary with output
• Variable Costs (TVC)
• Costs vary with output
• Total Costs (TC)
• TC = TFC + TVC
LO3
Per-Unit, or Average, Costs
• Average Fixed Costs
• Average Variable Costs
• Average Total Costs
• Marginal Costs
LO3
AFC = TFC/Q
AVC = TVC/Q
ATC = TC/Q
MC = ΔTC/ΔQ
Short-Run Production Costs
Table 7.2 Total, Average, and Marginal Cost Schedules for an Individual Firm in the Short Run
Total Cost Data
Average Cost Data
Marginal
Cost
(7)
Average
Total Cost
(ATC)
(8)
Marginal
Cost
(MC)
(4)
Total Cost
(TC)
(5)
Average
Fixed Cost
(AFC)
(6)
Average
Variable
Cost
(AVC)
TC=TFC+TVC
AFC = TFC/Q
AVC=TVC/Q
ATC = TC/Q
MC =ΔTC/ΔQ
(1)
Total
Product
(Q)
(2)
Total Fixed
Cost
(TFC)
(3)
Total
Variable
Cost
(TVC)
0
$100
$0
$100
1
100
90
190
$100.00
$90.00
$190.00
$90
2
100
170
270
50.00
85.00
135.00
80
3
100
240
340
33.33
80.00
113.33
70
4
100
300
400
25.00
75.00
100.00
60
5
100
370
470
20.00
74.00
94.00
70
6
100
450
550
16.67
75.00
91.67
80
7
100
540
640
14.29
77.14
91.43
90
8
100
650
750
12.50
81.25
93.75
110
9
100
780
880
11.11
86.67
97.78
130
10
100
930
1030
10.00
93.00
103.00
150
LO3
Long-Run Production Costs
• The firm can change all input
•
•
LO4
amounts, including plant size.
All costs are variable in the long run.
Long run ATC
• Each point reflects the lowest
possible ATC for that output level
Economies and Diseconomies of
Scale
• Economies of scale: downward sloping
portion of LR-ATC
• Increase in resources, output increases
more than proportionately
• Labor specialization
• Managerial specialization
• Efficient capital
• Other factors
LO4
Economies and Diseconomies of
Scale
• Constant returns to scale: horizontal
•
LO4
portion of LR-ATC
Diseconomies of scale: upslopint portion
of LR-ATC
• Control and coordination problems
• Communication problems
• Worker Alienation
• Shirking
MES and Industry Structure
• Minimum Efficient Scale (MES) is
• Lowest level of output where long
run average costs are minimized
• Can determine the structure of the
industry.
LO4
Applications and Illustrations
• Rising gasoline prices
• Successful start-up firms
• Verson stamping machine
• The daily newspaper
• Aircraft and concrete plants
LO3
