Chapter 9. Businesses and the Costs of Produc2on

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1 Chapter 9 Businesses and the Costs of Produc2on Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2 Economic Costs The payment that must be made to obtain and retain the services of a resource Explicit costs Monetary outlay Implicit costs Opportunity cost of using self- owned resources Value of next- best use Includes a normal profit LO1 9-2

3 Accounting Profit and Normal Accoun3ng profit Profit = Total revenue explicit costs Economic profit = Accoun2ng profit implicit costs Economic profit (to summarize) = Revenue economic cost = Revenue explicit costs implicit costs LO1 9-3

4 Economic Profit Economic profit Economic (opportunity) costs Implicit costs (including a normal profit) Explicit costs Total revenue Accoun3ng profit Accoun3ng costs (explicit costs only) LO1 9-4

5 Short Run and Long Run Short run Some variable inputs Fixed plant Long run All inputs are variable Firms can adjust plant size as well as enter and exit industry LO2 9-5

6 Short Run Production Relationships Total product (TP) Marginal product (MP) Marginal product Average product (AP) = change in total product change in labor input Average product = total product units of labor LO2 9-6

7 Law of Diminishing Returns Law of diminishing returns Resources are of equal quality Technology is fixed Variable resources are added to fixed resources At some point, marginal product will fall Ra2onale LO2 9-7

8 The Law of Diminishing Returns Total, Marginal, and Average Product: The Law of Diminishing Returns (1) Units of the Variable Resource (Labor) (2) Total Product (TP) (3) Marginal Product (MP) Change in (2)/ Change in (1) (4) Average Product (AP), (2)/(1) Increasing marginal returns Diminishing marginal returns Nega2ve marginal returns

9 The Law of Diminishing Returns Total product, TP TP LO2 Marginal product, MP Increasing Marginal Returns Diminishing Marginal Returns Nega3ve Marginal Returns AP MP 9-9

10 Short Run Production Costs Fixed costs (TFC) Costs that do not vary with output Variable costs (TVC) Costs that do vary with output Total cost (TC) Sum of TFC and TVC TC = TFC + TVC LO3 9-10

11 Short-Run Production Costs $ TC TVC 700 Costs Fixed cost Total cost Variable cost 100 TFC LO Q 9-11

12 Per-Unit, or Average, Costs Average fixed cost AFC = TFC/Q Average variable cost AVC = TVC/Q Average total cost ATC = TC/Q Marginal cost MC = ΔTC/ΔQ LO3 9-12

13 Short-Run Production Costs LO3 Total, Average, and Marginal Cost Schedules for an Individual Firm in the Short Run (1) Total Product (Q) (2) Total Fixed Cost (TFC) Total Cost Data (3) Total Variable Cost (TVC) (4) Total Cost (TC) TC=TFC+TVC 0 $100 $0 $100 (5) Average Fixed Cost (AFC) AFC = TFC/Q Average Cost Data (6) Average Variable Cost (AVC) AVC=TVC/Q (7) Average Total Cost (ATC) ATC = TC/Q Marginal Cost (8) Marginal Cost (MC) MC =ΔTC/ΔQ $ $90.00 $ $

14 Per-Unit, or Average, Costs $ Costs 100 AFC ATC AVC 50 AVC AFC Q LO3 9-14

15 Marginal Cost $ MC Costs 100 AFC ATC AVC 50 AVC AFC Q LO3 9-15

16 Marginal Cost and Marginal Product Average product and marginal product MP AP Quan3ty of labor Cost (dollars) MC AVC LO3 Quan3ty of output Cost curves 9-16

17 Long Run Production Costs The firm can change all input amounts, including plant size All costs are variable in the long run Long run ATC Different short run ATCs LO4 9-17

18 Firm Size and Costs Average total costs ATC- 1 ATC- 2 ATC- 3 ATC- 4 ATC- 5 Output LO4 9-18

19 The Long-Run Cost Curve Average total costs ATC- 1 ATC- 2 ATC- 3 ATC- 4 ATC- 5 Long- run ATC Output LO4 9-19

20 Economies of Scale Economies of scale Labor specializa2on Managerial specializa2on Efficient capital Other factors Constant returns to scale LO4 9-20

21 Diseconomies of Scale Diseconomies of scale Control and coordina2on problems Communica2on problems Worker aliena2on Shirking LO4 9-21

22 MES and Industry Structure Minimum efficient scale (MES) Lowest level of output at which long run average costs are minimized Can determine the structure of the industry Natural monopoly Long run costs are minimized when one firm produces the product LO4 9-22

23 MES and Industry Structure Average total costs Economies of scale Constant returns to scale Diseconomies of scale Long- run ATC q 1 q 2 Output LO5 9-23

24 MES and Industry Structure Average total costs Economies of scale Diseconomies of scale Long- run ATC Output LO5 9-24

25 MES and Industry Structure Average total costs Economies of scale Diseconomies of scale Long- run ATC Output LO5 9-25

26 Applications and Illustrations Rising gasoline prices Successful start- up firms Verson stamping machine The daily newspaper Aircrah and concrete plants LO5 9-26

27 3D Printers and Mass Customization First industrial revolu2on began in 1700s Mass produc2on led to mass affordability Second industrial revolu2on began late 1800s Mass sales were necessary to spread R&D costs Third industrial revolu2on is beginning Now Affordable mass customiza2on with zero transporta2on costs 9-27