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The Costs of Production

The Costs of Production. ECONOMIC COSTS. Explicit + Implicit costs Explicit costs Monetary payments to others Implicit costs Opportunity costs of owner Self-owned resources Self-employed resources. PROFITS. Accounting profit Total revenue minus explicit cost. Economic profit

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The Costs of Production

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  1. The Costs of Production

  2. ECONOMIC COSTS • Explicit + Implicit costs • Explicit costs • Monetary payments to others • Implicit costs • Opportunity costs of owner • Self-owned resources • Self-employed resources

  3. PROFITS • Accounting profit • Total revenue minus explicit cost • Economic profit • Total revenue minus implicit and explicit costs • Normal Profit = Implicit costs

  4. Economic Profit Accounting Profit Implicit Costs (normal profit) Explicit Costs Explicit Costs ECONOMIC COSTS Profits to an Economist Profits to an Accountant T O T A L R E V E N U E Economic (opportunity) Costs

  5. SHORT RUN AND LONG RUN • The short run • Fixed plant capacity • Variable plant usage • Variable output • The long run • Variable plant capacity • Firms enter and exit

  6. 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)

  7. Total Fixed Costs Average Fixed Costs = Quantity Total Variable Costs Average Variable Costs = Quantity SHORT-RUN PRODUCTION COSTS Fixed Costs (TFC or AFC) Total Fixed Costs Variable Costs (TVC or AVC) Total Variable Costs

  8. Total Costs Average Total Cost = Quantity Change in Total Costs Marginal Cost = Change in Quantity SHORT-RUN PRODUCTION COSTS Total Cost (TC & ATC) Total Fixed + Total Variable Costs Marginal Cost (MC) Total Variable Costs

  9. SHORT-RUN PRODUCTION COSTS Summary Total Fixed Costs=TFC Total Variable Costs=TVC Total Costs=TC Average Fixed Costs=AFC Average Variable Costs=AVC Average Total Costs=ATC Marginal Cost= MC

  10. Test Scores • If your current average is 86% and you scored a 73% on the most recent test, did your class average go up or down? • Down

  11. Test Scores • Your average grade is a 64%. You scored an 82% on the marginal assignment. What happened to your average grade? • It went up.

  12. Production • If your MP is higher than your AP then… • AP goes up. • If your MP is lower than your AP then… • AP goes down. • The same is true for MC and AVC.

  13. AP and MP Q of Labor P Q PRODUCTIVITY AND COST CURVES AP MP MC AVC

  14. SHORT-RUN COSTS GRAPHICALLY TC Combining TVC With TFC to get Total Cost P TVC Fixed Cost Variable Cost Total Cost TFC Q

  15. SHORT-RUN COSTS GRAPHICALLY Plotting Average and Marginal Costs MC P ATC AVC AFC Q

  16. Law of Diminishing Marginal Returns As more of a variable resource is added to a fixed resource, at some point, the MP of the variable resource will decline.

  17. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product TP Increasing Marginal Returns Quantity of Labor AP and MP Average Product Marginal Product Quantity of Labor

  18. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product TP Diminishing Marginal Returns Quantity of Labor AP and MP Average Product Marginal Product Quantity of Labor

  19. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product TP Negative Marginal Returns Quantity of Labor AP and MP Average Product Marginal Product Quantity of Labor

  20. Negative Marginal Returns

  21. SHORT-RUN COSTS GRAPHICALLY MC P ATC AVC AFC Q

  22. LONG-RUN PRODUCTION COSTS For every plant capacity size there is a short-run ATC curve. All such plant capacities can be plotted.

  23. LONG-RUN PRODUCTION COSTS P Q

  24. LONG-RUN PRODUCTION COSTS P Q

  25. LONG-RUN PRODUCTION COSTS P The long-run ATC just “envelopes” all of the short-run ATC curves. Q

  26. LONG-RUN PRODUCTION COSTS P LRATC Q

  27. ECONOMIES OF SCALE • Learning by Doing • Labor Specialization • Managerial Specialization • Efficient Capital • Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...

  28. ECONOMIES AND DISECONOMIES OF SCALE P Economies of scale LRATC Q

  29. ECONOMIES AND DISECONOMIES OF SCALE P Constant returns to scale Economies of scale LRATC Q

  30. ECONOMIES AND DISECONOMIES OF SCALE P Constant returns to scale Diseconomies of scale Economies of scale LRATC Q

  31. MINIMUM EFFICIENT SCALEAND INDUSTRY STRUCTURE • Minimum Efficient Scale – MES • Lowest output where you minimize cost

  32. LONG-RUN PRODUCTION COSTS P LRATC Q

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