Principles of Microeconomics : Ch.13 First Canadian Edition Supply The Costs of Production The Law...

Principles of Microeconomics : Ch.13 First Canadian Edition

Supply

The Costs of ProductionThe Law of Supply:

Firms are willing to produce and sell a greater quantity of a good when

the price of a good is high, due

to typical productivity and cost behaviour.


Total Revenue, Total Cost, Profit We assume that the firm’s goal is to

maximize profit.

Profit = Total revenue – Total costProfit = Total revenue – Total cost

TR-the amount a firm receives from the sale of its output

TC-the market value of the inputs a firm uses in production


Costs as Opportunity Costs The firm’s costs include Explicit Costs and

Implicit Costs:

– Explicit Costs: costs that involve a direct money outlay for factors of production.

– Implicit Costs: costs that do not involve a direct money outlay (e.g. opportunity costs of the owner’s own inputs used - implicit wages, implicit rent, cost of capital).


Costs as Opportunity Costs

Accountants measure the explicit costs but often ignore the implicit costs.

Economists include all opportunity costs when measuring costs.

Accounting Profit = TR - Explicit Costs Economic Profit = TR - Explicit Costs -

Implicit Costs


Explicit vs. Implicit Costs: An Example

You need $100,000 to start your business. The interest rate is 5%.

Case 1: borrow $100,000

– explicit cost = $5000 interest on loan

Case 2: use $40,000 of your savings, borrow the other $60,000

– explicit cost = $3000 (5%) interest on the loan– implicit cost = $2000 (5%) foregone interest you could

have earned on your $40,000.

In both cases, total (exp + imp) costs are $5000.


Marginal Product The marginal product of any input is the increase in

output arising from an additional unit of that input, holding all other inputs constant.

E.g., if Farmer Jack hires one more worker, his output rises by the marginal product of labour.

Notation: ∆ (delta) = “change in…”

Examples: ∆Q = change in output, ∆L = change in labour

Marginal product of labour (MPL) = delta Q/delta L


Why MPL Diminishes Diminishing marginal product:

the marginal product of an input declines as the quantity of the input increases (other things equal)E.g., Farmer Jack’s output rises by a smaller and smaller amount for each additional worker. Why?

If Jack increases workers but not land, the average worker has less land to work with, so will be less productive.

In general, MPL diminishes as L rises whether the fixed input is land or capital (equipment, machines, etc.).


Short-Run vs. Long-RunTwo different time horizons are important when analyzing costs. Short-Run: Time period over which some inputs are variable (labour, materials) and some inputs are fixed (plant size).Long-Run: Time period over which all inputs are variable, including plant size.


Short-Run Costs

Costs of production may be divided into two categories in the short-run:Fixed Costs:

–Those costs that do not vary with the amount of output produced.

Variable Costs:

–Those costs that do vary with the amount of output produced.


Marginal Cost Marginal Cost (MC)

is the increase in Total Cost from producing one more unit:

MC = delta TC/delta Q


The Shape of Short-Run Cost Curves

Short-run cost behaviour is based on the productivity of the inputs (resources).

As the firm continues to expand output,in a fixed plant-size situation, eventuallythe marginal product of each successive worker hired will decrease.

The diminishing marginal product causesthe marginal cost to increase in the short-run. This in turn affects the behaviour of average total cost.


The Shape of Typical Cost Curves

U-Shaped Average Total Cost (ATC):

– At low levels of output, as the firm expands production, ATC declines.

– At higher production levels, as output is increased, ATC increases.

– The bottom of the U-Shape occurs at the quantity that minimizes average total cost.

– This is called the Efficient Size of the firm.


The Relationship Between Marginal Cost and Average Total Cost

Why is ATC U - shaped? When marginal cost is less than average

total cost, average total cost is falling.

MC < ATC ATC When marginal cost is greater than average

total cost, average total cost is rising.

MC > ATC ATC


The Relationship Between Marginal Cost and Average Total Cost

Co

st (

$’s)

Quantity

MCATC

The marginal cost curve always crossesthe average total costcurve at the minimum

average total cost!


Costs in the Short Run & Long Run Short run:

Some inputs are fixed (e.g., factories, land). The costs of these inputs are FC.

Long run: All inputs are variable (e.g., firms can build more factories, or sell existing ones)

In the long run, ATC at any Q is cost per unit using the most efficient mix of inputs for that Q (e.g., the factory size with the lowest ATC).


Long-Run Costs

Econ.of Scale

Disecon. of Scale

Constant Returns to Scale

LRATC Curve

$ PerUnit

Scale of Operation (Q)


How ATC Changes as the Scale of Production Changes

Economies of scale occur when increasing production allows greater specialization: workers more efficient when focusing on a narrow task.– More common when Q is low.

Diseconomies of scale are due to coordination problems in large organizations. E.g., management becomes stretched, can’t control costs. – More common when Q is high. – Constant returns to scale if more output neither

increases or decreases cost. (flat portion of LRATC)

Principles of Microeconomics : Ch.13 First Canadian Edition Supply The Costs of Production The Law...

Documents

Transcript of Principles of Microeconomics : Ch.13 First Canadian Edition Supply The Costs of Production The Law...