chapter 20 production and costs
Download
Skip this Video
Download Presentation
Chapter 20: Production and Costs

Loading in 2 Seconds...

play fullscreen
1 / 84

Chapter 20: Production and Costs - PowerPoint PPT Presentation


  • 170 Views
  • Uploaded on

Chapter 20: Production and Costs. economic costs & profits short run long run. big picture. understand behavior of firm understand & measure production costs. I. economic costs & profits. firm’s goal: maximize profit look at factors that affect firm’s decision. economic costs.

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about ' Chapter 20: Production and Costs' - louvain


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
chapter 20 production and costs
Chapter 20: Production and Costs
  • economic costs & profits
  • short run
  • long run
big picture
big picture
  • understand behavior of firm
  • understand & measure
    • production
    • costs
i economic costs profits
I. economic costs & profits
  • firm’s goal:

maximize profit

  • look at factors that affect firm’s decision
economic costs
economic costs
  • opportunity cost of resources used
  • explicit costs
    • paid in money
    • wages, rent, material, etc.
  • implicit costs
    • opportunity cost of resources used
example smoothie shop
example: smoothie shop
  • explicit costs:
    • wages
    • interest on loan
    • rent on store
    • fruit, blenders
slide6
implicit costs
    • forgone interest on funds used to buy capital
    • owner’s forgone wages
    • owner’s forgone profit from other venture
accounting profit
accounting profit
  • total revenue – explicit costs
  • ignores opportunity cost
economic profit
economic profit
  • includes opp. costs

= total revenue - total costs

= (price)(quantity)

- (explicit + implicit costs)

normal profit
normal profit
  • occurs when
  • amount of accounting profit

= opportunity costs of resources

  • if earning a normal profit,
    • economic profit = 0
short run vs long run
Short Run vs. Long Run
  • Short Run (SR)
    • time frame where some resources are fixed

-- plants, equipment

    • some inputs variable

-- labor

    • SR decisions are reversible
slide12
Long Run (LR)
    • time frame where all inputs are variable

--build a bigger plant

    • LR decisions are hard to reverse

-- cannot easily get rid of capital

-- sunk cost

ii sr production
II. SR Production
  • measures of output
    • total product
    • marginal product
    • average product
total product tp
total product (TP)
  • total quantity of good produced

in a given period

  • at first, increases with labor,

then falls

tp gal of smoothies per hour
TP: gal. of smoothies per hour

# workers

TP

0

1

2

3

4

5

6

7

0

1

3

6

8

9

9

8

slide16

9

5 6

TP

# workers

marginal product mp
marginal product (MP)
  • change in TP due to one more worker

change in TP

=

change in labor

at first mp rises with workers
At first MP rises with workers
  • add more workers
  • greater specialization
  • MP of each worker added is larger

than previous worker

  • increasing marginal returns
then mp falls with more workers
then, MP falls with more workers
  • keep adding workers
  • but same amount of capital
  • so eventually get in the way
  • MP of more workers smaller than

MP of previous workers

  • decreasing marginal returns
tp mp gal of smoothies

1

2

3

2

1

0

-1

TP, MP: gal. of smoothies

# workers

TP

MP

0

1

2

3

4

5

6

7

0

1

3

6

8

9

9

8

slide21

3

0

3

MP

Q = # workers

law of decreasing returns
law of decreasing returns
  • As firm uses more labor
    • with capital fixed,
    • MP of labor will eventually fall
average product ap
Average Product (AP)

TP

=

labor

= productivity

slide24

1

2

3

2

1

0

-1

AP

# workers

TP

MP

0

1

2

3

4

5

6

7

0

1

3

6

8

9

9

8

1

1.5

2

2

1.8

1.5

1.1

slide25

3

0

3

MP

AP

# workers

mp ap
MP & AP
  • MP intersects AP at max of AP
  • why?
  • MP > AP
    • AP is rising
  • MP < AP
    • AP is falling
iii sr cost
III. SR cost
  • measure cost 3 ways:
    • total cost
    • marginal cost
    • average cost
total cost tc
Total Cost (TC)
  • cost of all factors used
  • total fixed cost (TFC)
    • cost of land, capital, etc.
    • does not change in SR
  • total variable cost (TVC)
    • cost of labor
    • changes in SR
  • TC = TFC + TVC
example yogurt
example : yogurt
  • labor = $6/ hour
  • TFC = $10/ hour
slide30

workers

TP

TFC

TVC

TC

0 0 10 0 10

1 1 10 6 16

1.6 2 10 9.6 19.6

2 3 10 12 22

10

10

4

5

8

9

24

30

34

40

slide31

TC

TC

TVC

TFC

10

Q = output

marginal cost
Marginal Cost
  • change in TC due to one-unit increase in output (Q)

change in TC

=

change in Q

slide33

TP

TFC

TVC

TC

6

3.6

2.4

6

MC

0 10 0 10

1 10 6 16

2 10 9.6 19.6

3 10 12 22

10

10

8

9

24

30

34

40

average cost atc
Average Cost (ATC)
  • = TC/Q
  • average fixed cost (AFC)
    • (TFC/Q)
  • average variable cost (AVC)
    • (TVC/Q)
  • ATC = AFC + AVC
slide35

TP

TFC

TVC

TC

AFC AVC AC

0 10 0 10

1 10 6 16

10 6 16

2 10 9.6 19.6

5 4.8 9.8

3 10 12 22

3.33 4 7.33

10

10

1.25 3 4.25

8

9

24

30

34

40

1.11 3.33 4.44

slide36

AC, MC

MC

ATC

AVC

AFC

Q = output

mc ac
MC & AC
  • MC intersects AC at its minimum
  • MC < AC
    • AC is falling
  • MC > AC
    • AC is rising
ac is u shaped
AC is U-shaped
  • why?
  • AFC falls with Q
  • AVC falls then rises
    • decreasing marginal returns
  • so ATC falls, then rises
cost product curves
cost & product curves
  • when MP is at maximum,

MC is at minimum

  • when AP is at maximum,

AVC is at minimum

what shifts cost curves
what shifts cost curves?
  • technology
    • make more with same inputs
    • shifts TP, MP, AP up
    • changes ATC curve
slide41
changes in factor prices
    • increase fixed costs

-- TFC, AFC shift up

-- TC shift up

    • increase wages (variable)

-- TVC, AVC, MC shift up

-- TC shift up

iv lr costs
IV. LR costs
  • all inputs (and costs) are variable
  • what happens if increase plant

AND labor by 10%?

    • ATC fall?
    • ATC rise?
    • ATC stay same?
economies of scale
Economies of scale
  • increase inputs 10%
    • output increase > 10%
    • ATC falls
  • why?
    • gains from specialization

-- labor

-- capital

diseconomies of scale
Diseconomies of scale
  • increase inputs 10%
    • output increase < 10%
    • ATC rises
  • why?
    • too hard to control large firm
constant returns to scale
Constant returns to scale
  • increase inputs 10%
    • output increase = 10%
    • ATC stays same
lr average cost lrac
LR Average Cost (LRAC)
  • lowest average cost when all inputs are variable
  • SRAC curves from different plant sizes
slide47

AC

ATC1

ATC2

ATC3

ATC4

Q = output

LRAC

slide48

AC

ATC1

ATC2

ATC3

ATC4

Q = output

diseconomies

of scale

economies

of scale

constant

returns

to

scale

summary
summary:
  • costs = implicit + explicit
  • SR, only labor variable
  • LR, all inputs variable
  • Production & costs
    • total, marginal, average
    • fixed, variable
slide50

The importance of the firm’s production function, the relationship between quantity of inputs and quantity of output

  • Why production is often subject to diminishing returns to inputs
  • The various types of costs a firm faces and how they generate the firm’s marginal and average cost curves
  • Why a firm’s costs may differ in the short run versus the long run
  • How the firm’s technology of production can generate increasing returns to scale
the production function
The Production Function

A production function is the relationship between the quantity of inputs a firm uses and the quantity of output it produces.

A fixed input is an input whose quantity is fixed for a period of time and cannot be varied.

A variable input is an input whose quantity the firm can vary at any time.

inputs and output
Inputs and Output

The long run is the time period in which all inputs can be varied.

The short run is the time period in which at least one input is fixed.

The total product curve shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input.

slide53

Production Function and TP Curve forGeorge and Martha’s Farm

Quantity of wheat (bushels)

Adding a 7th worker leads to an increase in output of only 7 bushels

Quantity of labor L

Quantity

of wheat Q

MP of labor

D

D

MPL

=

Q

/

L

(bushels per worker)

(worker)

(bushels)

0

0

Total product, TP

100

Adding a 2nd worker leads to an increase in output of only 17 bushels

19

1

19

17

2

36

80

15

3

51

13

60

4

64

11

5

75

9

40

6

84

7

7

91

20

5

8

96

0

1

2

3

4

5

6

7

8

Quantity of labor (workers)

slide54

Marginal Product of Labor

  • The marginal product of an input is the additional quantity of output that is produced by using one more unit of that input.
diminishing returns to an input
Diminishing Returns to an Input

There are diminishing returns to an input when an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input.

slide56

Marginal Product of Labor Curve

Marginal product of labor (bushels per worker)

There are diminishing returns to labor.

19

17

15

13

11

9

7

5

Marginal product of labor, MPL

0

1

2

3

4

5

6

7

8

Quantity of labor (workers)

slide57

Total Product, Marginal Product, and the Fixed Input

(a) Total Product Curves

(b) Marginal Product Curves

Quantity of wheat

(bushels)

Marginal product of labor

(bushels per worker)

160

30

TP

140

20

25

120

20

100

TP

10

80

15

60

10

40

MPL

20

5

20

MPL

10

0

1

2

3

4

5

6

7

8

0

1

2

3

4

5

6

7

8

Quantity of labor (workers)

Quantity of labor (workers)

from the production function to cost curves
From the Production Function to Cost Curves

A fixed cost is a cost that does not depend on the quantity of output produced. It is the cost of the fixed input.

A variable cost is a cost that depends on the quantity of output produced. It is the cost of the variable input.

total cost curve
Total Cost Curve

The total cost of producing a given quantity of output is the sum of the fixed cost and the variable cost of producing that quantity of output.

TC = FC + VC

The total cost curve becomes steeper as more output is produced due to diminishing returns.

total cost curve for george and martha s farm
Total Cost Curve for George and Martha’s Farm

Cost

Total cost, TC

$2,000

I

1,800

H

1,600

G

1,400

F

1,200

E

1,000

D

800

C

600

B

400

A

200

0

19

36

51

64

75

84

91

96

Quantity of wheat (bushels)

Variable cost

(VC)

Quantity of labor L

Quantity of wheat Q

Fixed Cost (FC)

Total cost

Point on graph

(worker)

(bushels)

(TC = FC + VC)

A

0

0

$

O

$400

$

400

B

1

19

200

400

600

C

2

36

400

400

800

D

3

51

600

400

1,000

E

4

64

800

400

1,200

F

5

75

1,000

400

1,400

G

6

84

1,200

400

1,600

H

7

91

1,400

400

1,800

I

8

96

1,600

400

2,000

slide61

The Mythical Man-Month

Quantity of software code (lines)

TP

Beyond a certain point, an additional programmer is counterproductive.

0

Quantity of labor (programmers)

Marginal product of labor (lines per programmer)

0

MPL

Quantity of labor (programmers)

two key concepts marginal cost and average cost
Two Key Concepts: Marginal Cost and Average Cost

As in the case of marginal product, marginal cost is equal to “rise” (the increase in total cost) divided by “run” (the increase in the quantity of output).

total cost and marginal cost curves for selena s gourmet salsas
Total Cost and Marginal Cost Curves for Selena’s Gourmet Salsas

(a) Total Cost

(b) Marginal Cost

Cost

Cost of case

8th case of salsa increases total cost by $180.

T

C

$1,400

$250

MC

1,200

200

1,000

2nd case of salsa increases total cost by $36.

150

800

600

100

400

50

200

0

1

2

3

4

5

6

7

8

9

10

0

1

2

3

4

5

6

7

8

9

10

Quantity of salsa (cases)

Quantity of salsa (cases)

why is the marginal cost curve upward sloping
Why is the Marginal Cost Curve Upward Sloping?
  • Because there are diminishing returns to inputs in this example. As output increases, the marginal product of the variable input declines.
  • This implies that more and more of the variable input must be used to produce each additional unit of output as the amount of output already produced rises.
  • And since each unit of the variable input must be paid for, the cost per additional unit of output also rises.
average cost
Average Cost

Average total cost, often referred to simply as average cost, is total cost divided by quantity of output produced.

ATC = TC/Q = (Total Cost) / (Quantity of Output)

A U-shaped average total cost curve falls at low levels of output, then rises at higher levels.

Average fixed cost is the fixed cost per unit of output.

AFC = FC/Q = (Fixed Cost) / (Quantity of Output)

average cost1
Average Cost

Average variable cost is the variable cost per unit of output.

AVC = VC/Q= (Variable Cost) / (Quantity of Output)

average total cost curve
Average Total Cost Curve

Increasing output has two opposing effects on average total cost:

The spreading effect: the larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower the average fixed cost.

The diminishing returns effect: the larger the output, the greater the amount of variable input required to produce additional units leading to higher average variable cost.

average total cost curve for selena s gourmet salsas
Average Total Cost Curve for Selena’s Gourmet Salsas

Cost of case

$140

Average total cost, ATC

Minimum average total cost

120

100

M

80

60

40

20

0

1

2

3

4

5

6

7

8

9

10

Quantity of salsa (cases)

Minimum-cost output

putting the four cost curves together
Putting the Four Cost Curves Together

Note that:

Marginal cost is upward sloping due to diminishing returns.

Average variable cost also is upward sloping but is flatter than the marginal cost curve.

Average fixed cost is downward sloping because of the spreading effect.

The marginal cost curve intersects the average total cost curve from below, crossing it at its lowest point. This last feature is our next subject of study.

marginal cost and average cost curves for selena s gourmet salsas
Marginal Cost and Average Cost Curves for Selena’s Gourmet Salsas

Cost of case

$250

MC

200

150

A

T

C

A

VC

100

M

50

AFC

0

1

2

3

4

5

6

7

8

9

10

Quantity of salsa (cases)

Minimum-cost output

general principles that are always true about a firm s marginal and average total cost curves
General Principles That Are Always True About a Firm’s Marginal and Average Total Cost Curves

The minimum-cost output is the quantity of output at which average total cost is lowest—the bottom of the U-shaped average total cost curve.

At the minimum-cost output, average total cost is equal tomarginal cost.

At output less than the minimum-cost output, marginal cost isless thanaverage total cost and average total cost is falling.

And at output greater than the minimum-cost output, marginal cost isgreater thanaverage total cost and average total cost is rising.

the relationship between the average total cost and the marginal cost curves
The Relationship Between the Average Total Cost and the Marginal Cost Curves

Cost of unit

MC

If marginal cost is above average total cost, average total cost is rising.

A

T

C

MC

H

B

2

A

1

M

B

A

1

2

MC

If marginal cost is below average total cost, average total cost is falling.

L

Quantity

does the marginal cost curve always slope upward
Does the Marginal Cost Curve Always Slope Upward?

In practice, marginal cost curves often slope downward as a firm increases its production from zero up to some low level, sloping upward only at higher levels of production.

This initial downward slope occurs because a firm that employs only a few workers often cannot reap the benefits of specialization of labor. This specialization can lead to increasing returns at first, and so to a downward-sloping marginal cost curve.

Once there are enough workers to permit specialization, however, diminishing returns set in.

more realistic cost curves
More Realistic Cost Curves

Cost of unit

MC

2. … but diminishing returns set in once the benefits from specialization are exhausted and marginal cost rises.

A

T

C

A

VC

1. Increasing specialization leads to lower marginal cost…

Quantity

short run versus long run costs
Short-Run versus Long-Run Costs

In the short run, fixed cost is completely outside the control of a firm. But all inputs are variable in the long run.

The firm will choose its fixed cost in the long run based on the level of output it expects to produce.

slide78

Choosing the Level of Fixed Cost of Selena’s Gourmet Salsas

Low fixed cost (FC = $108)

High fixed cost (FC = $216)

Average total cost of case

Average total cost of case

Quantity of salsa

Low variable cost

High variable cost

Total cost

Total cost

(salsa)

A

T

C

A

T

C

1

2

1

$

12

$

120

$120.00

$

6

$222

$222.00

2

48

156

78.00

24

240

120.00

3

108

216

72.00

54

270

90.00

4

192

300

75.00

96

312

78.00

5

300

408

81.60

150

366

73.20

6

432

540

90.00

216

432

72.00

7

588

696

99.43

294

510

72.86

8

768

876

109.50

384

600

75.00

9

972

1,080

120.00

486

702

78.00

10

1,200

1,308

130.80

600

816

81.60

Cost of case

At low output levels, low fixed cost yields lower average total cost

At high output levels, high fixed cost yields lower average total cost

$250

200

Low fixed cost

150

A

T

C

1

100

A

T

C

2

High fixed cost

50

0

1

2

3

4

5

6

7

8

9

10

Quantity of salsa (cases)

slide79

The long-run average total cost curve shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output.

The Long-run Average Total Cost Curve

short run and long run average total cost curves
Short-Run and Long-Run Average Total Cost Curves

Cost of case

Constant returns to scale

Increasing returns to scale

Decreasing returns to scale

A

T

C

A

T

C

A

T

C

L

R

A

T

C

3

6

9

B

Y

A

X

C

0

3

4

5

6

7

8

9

Quantity of salsa (cases)

returns to scale
Returns to Scale

There are increasing returns to scale (economies of scale) when long-run average total cost declines as output increases.

There are decreasing returns to scale (diseconomies of scale) when long-run average total cost increases as output increases.

There are constant returns to scale when long-run average total cost is constant as output increases.

slide82
The relationship between inputs and output is a producer’s production function. In the short run, the quantity of a fixed input cannot be varied but the quantity of a variableinput can. In the long run, the quantities of all inputs can be varied. For a given amount of the fixed input, the total product curve shows how the quantity of output changes as the quantity of the variable input changes.
  • There are diminishing returns to an input when its marginal product declines as more of the input is used, holding the quantity of all other inputs fixed.
  • Total cost is equal to the sum of fixed cost, which does not depend on output, and variable cost, which does depend on output.
slide83
Average total cost, total cost divided by quantity of output, is the cost of the average unit of output, and marginal cost is the cost of one more unit produced. U-shapedaverage total cost curves are typical, because average total cost consists of two parts: average fixed cost, which falls when output increases (the spreading effect), and average variable cost, which rises with output (the diminishing returns effect).
  • When average total cost is U-shaped, the bottom of the U is the level of output at which average total cost is minimized, the point of minimum-cost output. This is also the point at which the marginal cost curve crosses the average total cost curve from below.
slide84
In the long run, a producer can change its fixed input and its level of fixed cost. The long-run average total cost curve shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost at each level of output.
  • As output increases, there are increasing returns to scale if long-run average total cost declines; decreasingreturns to scale if it increases; and constant returns toscale if it remains constant. Scale effects depend on the technology of production.
ad