Course informa-on. Review ques-ons for second midterm (April 4 th ) on the course web site: h>p:// courses.umass.edu/econ103h

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1 Course informa-on Review ques-ons for second midterm (April 4 th ) on the course web site: h>p:// courses.umass.edu/econ103h Second midterm will have only 20 mul-ple choice and again a choice of 1 out of 2 short answer/ graphing ques-ons I will have extra office hours for the midterm this week Tuesday from 9 11 and Thursday from 2-5

2 To do today Finish costs Shape and rela-onship of short run cost curves Long run cost curves Why do we care? Profit maximiza-on depends on this informa-on

3 The shapes tell the economic story of increasing and then decreasing marginal product! Average fixed cost (AFC): Graphing cost curves

4 The average variable cost curve (AVC) Graphing cost curves The average total cost curve (ATC)

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7 Relationships among all cost curves The ver-cal distance between ATC and AVC curves is equal to AFC, as illustrated by the two arrows. The marginal cost curve (MC) is U- shaped and intersects the average variable cost curve and the average total cost curve at their minimum points.

8 Explaining the shape of the ATC The shape of the ATC curve combines the shapes of the AFC and AVC curves. The U shape of the average total cost curve arises from the influence of two opposing forces: Spreading total fixed cost over a larger output Increasing and then decreasing marginal returns

9 MC linked to MP If MP rises, MC falls. If MP is a maximum, MC is a minimum.

10 AVC linked to AP If AP rises, AVC falls. If AP is a maximum, AVC is a minimum.

11 Cost and product curves: three zones At small outputs, MP and AP é MC and AVC ê At intermediate outputs, MP ê MC é APé AVC ê At large outputs, MP and AP ê MC and AVC é

12 Shifts in product and cost curves Technological change if increases productivity shifts the TP curve upward. It also shifts the MP curve and the AP curve upward. also lowers the average and marginal costs and so shifts the short-run cost curves downward.

13 Shifts: Prices of factors of production An increase increases costs and shifts the cost curves. How the curves shift depends on which resource price changes..

14 Increase in a fixed cost Shifts the fixed cost curves (TFC and AFC) upward. Shifts the total cost curve (TC) upward Leaves the variable cost curves (AVC and TVC) and the marginal cost curve (MC) unchanged

15 Increase in a variable cost Shifts the variable curves (TVC and AVC) upward. Shifts the marginal cost curve (MC) upward. Leaves the fixed cost curves (AFC and TFC) unchanged.

16 Long run: All factors variable

17 Moving to the long run What is it? All factors of produc-on can change size (scale) of a factory can increase or decrease What happens next depends on the rela-onship between size (scale) and costs

18 Moving to the long run Three possible outcomes when a firm changes the size (scale) of its factory Economies of scale Diseconomies of scale Constant returns to scale

19 Economies of scale Increases plant size and labor employed by the same percentage Then output increases by a larger percentage Average total cost decreases Main source is greater specialization of both labor and capital.

20 Diseconomies of scale A firm increases plant size and labor employed by the same percentage Output increases by a smaller percentage Average total cost increases Why? Difficulty of coordinating and controlling a large enterprise. Eventually, management complexity brings rising average total cost.

21 Constant returns to scale A firm increases its plant size and labor employed by the same percentage Output increases by the same percentage Average total cost remains constant. Why? A firm is able to replicate its existing production facility including its management system.

22 What this looks like The long-run average cost curve shows the lowest average cost at which it is possible to produce each output when the firm has had sufficient time to change both its plant size and labor employed.

23 Long-run average cost curve Can vary all inputs to change the size (scale) With its current plant, Sam s ATC curve is ATC 1. With successively larger plants, Sam s ATC curves would be ATC 2, ATC 3, and ATC 4.

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25 EYE on RETAILERS COSTS Which Store Has the Lower Costs: Wal-Mart or 7 11? Wal- Mart s small supercenters measure 99,000 square feet and serve an average of 30,000 customers a week. The average 7 11 store, mostly a>ached to gas sta-ons, measures 2,000 square feet and serves 5,000 customers a week. Which retailing technology has the lower opera-ng cost? The answer depends on the scale of opera-on. At a small number of customers per week, it costs less per customer to operate a store of 2,000 square feet than a store of 99,000 square feet.

26 EYE on RETAILERS COSTS Which Store Has the Lower Costs: Wal-Mart or 7 11? The average total cost curve of opera-ng a store of 2,000 square feet is ATC The average total cost curve of a store of 99,000 square feet is ATC Wal- Mart. The dark blue curve is a retailer s LRAC curve.

27 EYE on RETAILERS COSTS Which Store Has the Lower Costs: Wal-Mart or 7 11? With Q customers a week, the average total cost of a transac-on is the same in both stores. For a store that serves fewer than Q customers a week, the least- cost method is the small store.