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The Costs of Production Chp: 8

The Costs of Production Chp: 8. Lecture: 15 & 16. Economic Costs. Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments Implicit costs Value of next best use Self-owned resources Self-employed resources. 8- 2. Profit. Accounting profit

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The Costs of Production Chp: 8

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  1. The Costs of Production Chp: 8 Lecture: 15 & 16

  2. Economic Costs • Equal to opportunity costs • Explicit + implicit costs • Explicit costs • Monetary payments • Implicit costs • Value of next best use • Self-owned resources • Self-employed resources 8-2

  3. Profit • Accounting profit • Total revenue less explicit cost • Normal profit • Equal to implicit cost • Economic or pure profit • Total revenue less economic cost 8-3

  4. Economic Accounting Profits Compared Accounting Profit Economic Profit Implicit Costs (Including Normal Profit) Total Revenue Economic (Opportunity) Costs Explicit Costs Accounting Costs (Explicit Costs Only) 8-4

  5. Short and Long Run • The short run • Fixed plant capacity • Variable intensity of plant use • Variable output • The long run • Variable plant capacity • Firms enter and exit 8-5

  6. Change in Total Product = Marginal Product Change in Labor Input Total Product = Average Product Units of Labor Production Relationships • Total product (TP) • Marginal product (MP) • Average product (AP) 8-6

  7. Law of Diminishing Returns • Fixed technology • Add variable resource to fixed resource • Marginal product will decline • Beyond some point • Rationale 8-7

  8. (3) Marginal Product (MP), Change in (2)/ Change in (1) (3) Average Product (AP), (2)/(1) (1) Units of the Variable Resource (Labor) (2) Total Product (TP) ] ] ] ] ] ] ] ] Law of Diminishing Returns - 10.00 12.50 15.00 15.00 14.00 12.50 10.71 8.75 0 10 25 45 60 70 75 75 70 0 1 2 3 4 5 6 7 8 10 15 20 15 10 5 0 -5 Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 8-8

  9. Law of Diminishing Returns 30 Total Product, TP 20 10 0 20 Marginal Product, MP 10 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 TP Increasing Marginal Returns Negative Marginal Returns Diminishing Marginal Returns AP MP 8-9

  10. Short-Run Production Costs • Fixed Costs • Do not vary with output • Variable Costs • Materials, most labor • Total Cost • TC = TFC + TVC 8-10

  11. Per-Unit Production Costs • Average fixed cost AFC = TFC/Q • Average variable cost AVC = TVC/Q • Average total cost ATC = TC/Q = TFC/Q + TVC/Q ATC = AFC+AVC • Marginal cost MC = change in TC/change in Q 8-11

  12. $1100 1000 900 800 700 600 Costs 500 400 300 200 100 0 10 1 2 3 4 5 6 7 8 9 Q Short-Run Production Costs TC TVC Fixed Cost Total Cost Variable Cost TFC 8-12

  13. $200 150 100 Costs 50 0 10 1 2 3 4 5 6 7 8 9 Q Short-Run Production Costs MC ATC AVC AFC AVC AFC 8-13

  14. Production Relationships • Marginal cost and diminishing returns • Marginal cost and marginal product • Marginal cost and average variable cost • Marginal cost and average total cost • Production curves and cost curves • Shifts in cost curves 8-14

  15. Average Product and Marginal Product Cost (Dollars) Graphical Relationships Production Curves AP MP Quantity of Labor MC AVC Cost Curves Quantity of Output 8-15

  16. Long-Run Production Costs • Choose your plant size • Minimize ATC • Different ATC curves • Short run • Long run ATC • Envelope of short run ATC 8-16

  17. Long-Run ATC Curve ATC-1 ATC-5 ATC-2 ATC-4 ATC-3 Average Total Costs Output Any number of short-run optimum size cost curves can be constructed 8-17

  18. Long-Run ATC Curve ATC-1 ATC-5 ATC-2 Long-Run ATC ATC-4 ATC-3 Average Total Costs Output The long-run ATC curve just “envelopes” the short run ATCs 8-18

  19. Long Run Production Cost • Economies of Scale • Labor specialization • Managerial specialization • Efficient capital • Diseconomies of Scale • Constant Returns to Scale 8-19

  20. Long-Run ATC Shapes Diseconomies Of Scale Constant Returns To Scale Economies Of Scale Average Total Costs Long-Run ATC q1 q2 Output Long-run ATC curve where economies of scale exist 8-20

  21. Long-Run ATC Shapes Economies Of Scale Diseconomies Of Scale Average Total Costs Long-Run ATC Output Long-run ATC curve where costs are lowest only when large numbers are participating 8-21

  22. Long-Run ATC Shapes Diseconomies Of Scale Economies Of Scale Long-Run ATC Average Total Costs Output Long-run ATC curve where economies of scale exist, are exhausted quickly, and turn back up substantially 8-22

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