Production and Cost Analysis I

Transcription

1 CHAPTER 12 Production and Cost Analysis I Production is not the application of tools to materials, but logic to work. Peter Drucker McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

2 The Role of the Firm A firm is an economic institution that transforms factors of production into goods and services Firms: 1. Organize factors of production and/or 2. Produce goods and services and/or 3. Sell produced goods and services 12-2

3 Firms Maximize Profit The goal of a firm is to maximize profits Profit = Total Revenue Total Cost For economists, total cost is explicit payments to the factors of production plus the opportunity cost of the factors provided by the owners of the firm 12-3

4 Firms Maximize Profit For economists, total revenue is the amount a firm receives for selling its product or service plus any increase in the value of the assets owned by the firm McGraw-Hill/Irwin Colander, Economics 4

5 Firms Maximize Profit Economists and accountants measure profit differently Explicit cost =money paid out (rent, wages, etc.) Implicit cost=opportunity cost of the factors of production used by the firm 12-5

6 Firms Maximize Profit Accountants focus on explicit costs and revenues Accounting profit = explicit revenue explicit cost McGraw-Hill/Irwin Colander, Economics 6

7 Firms Maximize Profit Economists focus on both explicit and implicit costs and revenue Economic profit = (explicit and implicit revenue) (explicit and implicit cost) McGraw-Hill/Irwin Colander, Economics 7

8 The Production Process The production process can be divided into the short run and the long run Short Run A firm is limited in regard to what production decisions it can make Some inputs are fixed Long Run A firm chooses from all possible production techniques All inputs are variable McGraw-Hill/Irwin Colander, Economics 8

9 What do the long run and short run mean? The terms short run and long run refer to the flexibility that the firm has in changing the level of output McGraw-Hill/Irwin Colander, Economics 9

10 Production Tables and Production Functions A production table is a table showing the output resulting from various combinations of factors of production or inputs 12-10

11 A Production Table (P. 281) # of workers Total Output Marginal Product Average Product Average product is the output per worker Marginal product is the additional output that comes from an additional worker, other inputs constant 12-11

12 The Production Function The production function tells the maximum amount of output that can be derived from a given number of inputs Note it has three stages McGraw-Hill/Irwin Colander, Economics 12

13 Q Graphing a Production Function TP A production function is the relationship between then inputs and the outputs 2 Increasing marginal productivity Diminishing marginal productivity Diminishing Absolute productivity Number of workers 12-13

14 Graphing Marginal and Average Productivity Q AP Marginal Eventually Then productivity marginal productivity first increases is declines negative Number of workers -4-6 Increasing marginal productivity Diminishing marginal productivity MP Diminishing Absolute productivity 12-14

15 Law of Diminishing Marginal Productivity # of workers Total Output Marginal Product Average Product Law of diminishing marginal productivity states as more of a variable input is added to an existing fixed input, after some point the additional output from the additional input will fall Increasing marginal productivity Diminishing marginal productivity Diminishing Absolute productivity 12-15

16 The Costs of Production Fixed costs (FC) are those that are spent and cannot be changed in the period of time under consideration In the short run, a number of inputs and their costs will be fixed In the long run, there are NO fixed costs since all inputs are variable 12-16

17 The Costs of Production Variable costs (VC) are costs that change as output changes Workers are an example of VC Total cost (TC) is the sum of the variable and fixed costs TC = FC + VC McGraw-Hill/Irwin Colander, Economics 17

18 The Costs of Production Average fixed costs (AFC) equals fixed cost divided by quantity produced AFC = FC/Q Average variable costs (AVC) equals variable cost divided by quantity produced AVC = VC/Q 12-18

19 The Costs of Production Average total cost (ATC) equals total cost divided by quantity produced ATC = TC/Q or ATC = AFC + AVC Marginal cost (MC) is the increase in total cost when output increases by one unit MC = ΔTC/ΔQ McGraw-Hill/Irwin Colander, Economics 19

20 Costs of Production Table Output FC ($) VC ($) TC ($) MC ($) AFC ($) AVC ($) ATC ($)

21 The Shapes of Cost Curves The variable and total cost curves have the same shape Increasing output increases VC and TC The fixed cost curve is always constant Increasing output doesn t change FC 12-21

22 Graphing Total Cost Curves Total Cost TC VC TC and VC curves increase as Q increases FC Q FC curve is constant 12-22

23 The Shapes of Cost Curves The average fixed cost (AFC) curve is downward sloping Increasing output decreases AFC The marginal cost (MC), average variable cost (AVC), and average total cost curves (ATC) are U-shaped Increasing output initially leads to a decrease in MC, AVC, and ATC but eventually they increase McGraw-Hill/Irwin Colander, Economics 23

24 Graphing Per Unit Output Cost Curves Cost MC MC, ATC, and AVC curves are U-shaped ATC AVC AFC Q AFC curve decreases 12-24

25 The Shapes of Cost Curves The U-shape of ATC and AVC curves is due to: When output is increased in the short run, it can only be done by increasing the variable input The law of diminishing productivity causes marginal and average productivities to fall 12-25

26 The Shapes of Cost Curves As average and marginal productivities fall, average and marginal costs rise The marginal cost curve goes through the minimum points of the ATC and AVC curves (know this!) McGraw-Hill/Irwin Colander, Economics 26

27 The Relationship Between Marginal Cost and Average Cost Costs per unit MC ATC AVC The marginal cost curve goes through the minimum point of both the ATC and AVC curves Q 12-27

28 Costs per unit The Relationship Between Marginal Productivity and Marginal Costs Output worker per MC AVC Q If marginal productivity is rising, marginal costs are falling If average productivity is falling, average costs are rising AP of workers MP of workers Q 12-28

29 The Relationship Between Marginal Cost and Average Cost If MC > ATC, then ATC is rising If MC > AVC, then AVC is rising If MC < ATC, then ATC is falling If MC < AVC, then AVC is falling If MC = AVC and MC = ATC, then AVC and ATC are at their minimum points 12-29

30 Chapter Summary Accounting profit is explicit revenue less explicit cost Economists include implicit revenue and cost in determining economic profit Implicit revenue includes the increases in the value of assets owned by the firm Implicit costs include opportunity cost of time and capital provided by owners of the firm In the long run a firm can choose among all possible production techniques; in the short run it is constrained in its choices because at least one input is fixed 12-30

31 Chapter Summary The law of diminishing marginal productivity states that as more of a variable input is added to a fixed input, the additional output will eventually be decreasing Costs are generally divided into fixed costs, variable costs, and marginal costs TC = FC + VC MC = ΔTC/ΔQ AFC = FC/Q AVC = VC/Q ATC = AFC + AVC 12-31

32 Chapter Summary AVC and MC are mirror images of the average and marginal products The law of diminishing marginal productivity causes marginal and average costs to rise MC goes through the minimum points of the AVC and ATC If MC > ATC, then ATC is rising If MC = ATC, then ATC is constant If MC < ATC, then ATC is falling 12-32

33 Production and Cost Analysis II 13 CHAPTER 13 Production and Cost Analysis II Economic efficiency consists of making things that are worth more than they cost. J. M. Clark McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

34 Production and Cost Analysis II 13 Making Long-Run Production Decisions Firms have more options in the long run and they can change any input they want Firms look at costs of various inputs and the technologies available for combining these inputs 13-34

35 Production and Cost Analysis II 13 Technical Efficiency and Economic Efficiency Technical efficiency in production means that as few inputs as possible are used to produce a given output 13-35

36 Production and Cost Analysis II 13 Technical Efficiency and Economic Efficiency The economically efficient method of production produces a given level of output at the lowest possible cost In the long run, firms will look at all available production techniques and choose the technology that, given available inputs and prices, is economically efficient McGraw-Hill/Irwin Colander, Economics 36

37 Production and Cost Analysis II 13 Determinants of the Shape of the Long-Run Cost Curve The law of diminishing marginal productivity does not apply in the long run since all inputs are variable The shape of the long-run cost curve is due to the existence of economies and diseconomies of scale 13-37

38 Production and Cost Analysis II 13 Economies of Scale Economies of scale exist when long-run average total costs decrease as output increases These are shown by the downward sloping portion of the long-run average total cost curve Indivisible setup costs create many real-world economies of scale 13-38

39 Production and Cost Analysis II 13 Economies of Scale An indivisible setup cost is the cost of an indivisible input for which a certain minimum amount of production must be undertaken before the input becomes economically feasible to use This is important because as output increases, the costs per unit decrease McGraw-Hill/Irwin Colander, Economics 39

40 Production and Cost Analysis II 13 Economies of Scale Example: The cost of a blast furnace or an oil refinery is an example of an indivisible setup cost McGraw-Hill/Irwin Colander, Economics 40

41 Production and Cost Analysis II 13 Economies of Scale The minimum efficient level of production is the amount of production that spreads setup costs out sufficiently for firms to undertake production profitably 13-41

42 Production and Cost Analysis II 13 Economies of Scale The minimum efficient level of production is reached once the size of the market expands to a size large enough for firms to take advantage of all economies of scale This is where average total costs are at a minimum McGraw-Hill/Irwin Colander, Economics 42

43 Production and Cost Analysis II 13 Diseconomies of Scale Diseconomies of scale exist when long-run average total costs increase as output increases These are shown by the upward sloping portion of the long-run average total cost curve Diseconomies of scale usually, but not always, start occurring as firms get large 13-43

44 Production and Cost Analysis II 13 A Typical Long-Run Average Total Cost Curve Costs per unit $60 $55 Minimum efficient level of production Long-run average total cost (LRATC) $50 11 ATC falls because of economies of scale ATC is constant because ATC rises because of of constant returns to diseconomies of scale scale Q 13-44

45 Production and Cost Analysis II 13 Diseconomies of Scale Two reasons for diseconomies of scale are: 1. As the size of firms increase, monitoring costs generally increase Monitoring costs: the costs incurred by the organizer of production (seeing to it that the employees do what they are supposed to do) 13-45

46 Production and Cost Analysis II 13 Diseconomies of Scale 2. As the size of firms increase, team spirit/morale decreases The larger the firm, the more difficult this becomes McGraw-Hill/Irwin Colander, Economics 46

47 Production and Cost Analysis II 13 Constant Returns to Scale Constant returns to scale exist when average total costs do not change as output increases This is shown by the flat portion of the longrun average total cost curve Constant returns to scale occur when production techniques can be replicated again and again to increase output 13-47

48 Production and Cost Analysis II 13 A Typical Long-Run Average Total Cost Table Q TC of Labor ($) TC of Machines ($) TC ($) ATC ($) ATC falls because of economies of scale ATC is constant because of constant returns to scale ATC rises because of diseconomies of scale 13-48

49 Production and Cost Analysis II 13 The Envelope Relationship The envelope relationship is the relationship between long-run and short run average total costs Remember: In the long run, all inputs are flexible/variable In the short run, some inputs are fixed 13-49

50 Production and Cost Analysis II 13 The Envelope Relationship (continued) So, if we have a LRATC we can see that it is an envelope of SRATCs Each short-run cost curve touches the longrun cost curve at only one point Each SRATC curve will always be above or tangent to the LRATC curve McGraw-Hill/Irwin Colander, Economics 50

51 Production and Cost Analysis II 13 The Envelope of Short-Run Average Total Cost Curves Costs per unit LRATC SRATC SRATC 4 1 SRMC 1 SRMC 4 SRATC 2 SRMC 2 SRATC 3 SRMC 3 The long-run average total cost curve (LRATC) is an envelope of the short-run average total cost curves (SRATC 1-4 ) Q 13-51

52 Production and Cost Analysis II 13 Using Cost Analysis in the Real World The cost of production of one product often depends on what other products a firm is producing There are economies of scope when the costs of producing goods are interdependent so that it is less costly for a firm to produce one good when it is already producing another 13-52

53 Production and Cost Analysis II 13 Using Cost Analysis in the Real World Learning by doing means that as we do something, we learn what works and what doesn t, and over time we become more proficient at it Technological change is an increase in the range of production techniques that leads to more efficient ways of producing goods and the production of new and better goods 13-53

54 Production and Cost Analysis II 13 Chapter Summary An economically efficient production process must be technically efficient, but a technically efficient process may not be economically efficient The long-run average total cost curve is U-shaped because economies of scale cause average total cost to decrease; diseconomies of scale eventually cause average total cost to increase Marginal cost and short-run average cost curves slope upward because of diminishing marginal productivity 13-54

55 Production and Cost Analysis II 13 Chapter Summary The long-run average cost curve slopes upward because of diseconomies of scale The envelope relationship between short-run and long-run average cost curves reflects that the shortrun average cost curves are always above the longrun average cost curve, except at just one point An entrepreneur is an individual who sees an opportunity to sell an item at a price higher than the average cost of producing it 13-55

56 Production and Cost Analysis II 13 Chapter Summary Once we start applying cost analysis to the real world, we must include a variety of other dimensions of costs that the standard model does not cover Costs in the real world are affected by: Economies of scope Learning by doing and technological change Many dimensions to output Unmeasured costs, such as opportunity costs 13-56