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The Costs of Production PowerPoint PPT Presentation


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20. The Costs of Production. Chapter Objectives. Why Do Economic Costs Include Both Explicit Costs and Implicit Costs How Does the Law of Diminishing Returns Relate to a Firm’s Short-Run Production Costs

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The costs of production

20

The Costs of

Production


Chapter objectives

Chapter Objectives

  • Why Do Economic Costs Include Both Explicit Costs and Implicit Costs

  • How Does the Law of Diminishing Returns Relate to a Firm’s Short-Run Production Costs

  • Learn the Distinctions Between Fixed and Variable Costs and Among Total, Average, and Marginal Costs

  • Learn the Link Between a Firm’s Size and Its Average Costs in the Long Run


Economic costs

W 20.1

Economic

Profit

Total

Revenue

Economic

Cost

-

=

Economic Costs

  • Economic Cost

  • Opportunity Cost

  • Explicit Costs

  • Implicit Costs

  • Normal Profit as a Cost

  • Economic or Pure Profit


Profits compared

Economics

Accounting

Profits Compared

Economic Profit Versus Accounting Profits

Accounting

Profit

Economic

Profit

Implicit Costs

(Including a

Normal Profit)

Economic

(Opportunity)

Costs

Total Revenue

Explicit

Costs

Accounting

Costs (Explicit

Costs Only)

  • Short Run and Long Run

    • Short Run: Fixed Plant

    • Long Run: Variable Plant


Short run production relationships

W 20.2

Change in Total Product

=

Marginal Product

Change in Labor Input

Total Product

=

Average Product

Units of Labor

Short-Run Production Relationships

  • Total Product (TP)

  • Marginal Product (MP)

  • Average Product (AP)


Law of diminishing returns

O 20.1

(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

  • Rationale

  • Tabular Example

-

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


Law of diminishing returns1

O 20.2

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

Law of Diminishing Returns

  • Graphical Portrayal

TP

Increasing

Marginal

Returns

Negative

Marginal

Returns

Diminishing

Marginal

Returns

AP

MP


Short run production costs

Short-Run Production Costs

  • Fixed Costs

  • Variable Costs

  • Total Cost

    TC = TFC + TVC


Short run production costs1

TFC

TVC

AFC =

AVC =

Q

Q

TC

= AFC + AVC

ATC =

Q

Change in TC

MC =

Change in Q

Short-Run Production Costs

  • Per-Unit or Average Costs

    • Average Fixed Cost (AFC)

    • Average Variable Cost (AVC)

    • Average Total Cost (ATC)

    • Marginal Cost (MC)

Graphically…


Short run production costs2

$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

Total Cost, Fixed and Variable Costs

TC

TVC

Fixed

Cost

Total

Cost

Variable

Cost

TFC


Short run production costs3

G 20.1

$200

150

100

Costs

50

0

10

1

2

3

4

5

6

7

8

9

Q

Short-Run Production Costs

Average and Marginal Costs

MC

AFC

ATC

AVC

AVC

AFC


Short run production costs4

W 20.3

Short-Run Production Costs

  • MC and Marginal Product

  • Marginal Decisions

  • Relation of MC to AVC and ATC

  • Relationship Between Productivity Curves and Cost Curves

  • Shifts in Cost Curves

    Graphically…


Short run production costs5

Average Product and

Marginal Product

Cost (Dollars)

Short-Run Production Costs

Production Curves

AP

MP

Quantity of Labor

Cost Curves

MC

AVC

Quantity of Output


Long run production costs

Long-Run Production Costs

  • Firm Size and Costs

  • Long-Run Cost Curve

  • Economies of Scale

    • Labor Specialization

    • Managerial Specialization

    • Efficient Capital

  • Diseconomies of Scale

  • Constant Returns to Scale


Long run production costs1

Long-Run Production Costs

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


Long run production costs2

Long-Run Production Costs

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


Long run production costs3

Long-Run Production Costs

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


Long run production costs4

Long-Run Production Costs

Alternative 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


Long run production costs5

Long-Run Production Costs

Alternative 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


Long run production costs6

Long-Run Production Costs

Alternative 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


Minimum efficient scale and industry structure

O 20.3

Minimum Efficient Scale and Industry Structure

  • Minimum Efficient Scale (MES)

  • Natural Monopoly

  • Applications and Illustrations

    • Rising Cost of Insurance and Security

    • Successful Start-Up Firms

    • The Verson Stamping Machine

    • The Daily Newspaper

    • Aircraft and Concrete Plants


Don t cry over sunk costs

Don’t Cry Over Sunk Costs

Last

Word

  • Sunk Costs Irrelevant in Decision Making

  • Once Incurred, They Cannot Be Recovered

  • Compare Marginal Analysis to Find MC and MB

  • Previously Incurred Costs Do Not Impact the MB=MC Decision

  • Sunk Costs Are Irrelevant!


Key terms

economic (opportunity) cost

explicit costs

implicit costs

normal profit

economic profit

short run

long run

total product (TP)

marginal product (MP)

average product (AP)

law of diminishing returns

fixed costs

variable costs

total cost

average fixed cost (AFC)

average variable cost (AVC)

average total cost (ATC)

marginal cost (MC)

economies of scale

diseconomies of scale

constant returns to scale

minimum efficient scale (MES)

natural monopoly

Key Terms


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Pure

Competition

Chapter 21!


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