Charles Bonnet-Considerations Sur Les Corps Organises 1768 I
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Transcript of Slide: 1 TOPIC 4 PRODUCTION AND COSTS. Slide: 2 The Firm and Its Economic Problem Firm An...
Slide: 2
The Firm and ItsEconomic Problem
Firm
An institution that hires productive resources and that organises those resources to produce and sell goods and services
A firm’s goal is to maximize profit subject to a budget constraint
Slide: 3
Opportunity Cost
Firms incur opportunity costs when they produce goods.
Opportunity cost of producing — the best alternative investment opportunity that the firm foregoes to produce a good or service
Look at it as the opportunity costs of the factors of production the firm employs (labor, capital, entrepreneurs)
Slide: 4
Opportunity Cost
Components of a firm’s opportunity cost
Explicit costs (money costs)
The amount paid for factors of production
Implicit costs (non-money costs)
The value of foregone opportunities.
The firm incur implicit costs when it: uses its own capital uses its owner’s time or financial resources
Slide: 5
Opportunity Cost
Cost of Capital
Economic depreciation is the change in the market price of a durable input over a given time period (not the same as accounting depreciation).
Interest is the funds used to buy capital that could have been used for some other purpose.
Implicit rental rate is the income that the firm forgoes by using the assets itself and not renting them to another firm — the same as economic depreciation and interest costs.
Slide: 6
Opportunity Cost
Cost of Owner’s Resources
The income that the owner could have earned in the best alternative job.
Normal profit is the expected return for supplying entrepreneurial ability.
Slide: 7
Economic Profit
Economic Profit
A firm’s total revenue minus its opportunity costs.
Not the same as accounting profit.
Slide: 8
The Firm and Its Economic Problem
The Firm’s Constraints
Three features of its environment limit the maximum profit a firm can make. They are: Technology
Information
Market
Slide: 9
The Firm and Its Economic Problem
Technology Constraints A firm’s resources and the available technology limit its
production.
Information Constraints The cost of coping with limited information itself limits profit.
Market Constraints Willingness to pay of its customers and by the prices and
marketing efforts of rival firms.
Willingness of people to work for and invest in the firm.
Slide: 10
Technology and Economic Efficiency
Technological efficiency
Occurs when it is not possible to increase output without increasing inputs
Economic efficiency
Occurs when the cost of producing a given output is as low as possible
Slide: 11
Technological and Economic Efficiency
While technological efficiency depends only on what is feasible, economic efficiency depends on the relative cost of resources.
The economically efficient method is the one that uses the smallest amount of a more expensive resource and a larger amount of a less expensive resource.
Slide: 12
Information and Organisation
Organization of resources within the firm has a direct relation to the ability of the firm to achieve efficient outcomes
Command systems are based upon a managerial hierarchy.
Incentive systems are market-like mechanisms that firms create within their organisations. These systems are designed to strengthen incentives
and raise productivity.
Slide: 13
The Principal-Agent Problem
Principal-agent problem
The problem of devising compensation rules that induce an agent to act in the best interest of the principal
Three methods of attenuating the principal-agent problem are: Ownership Incentive pay Well-specified contracts
Slide: 14
The Principal-Agent Problem
Ownership
By assigning a manager or worker ownership of a business, it is sometimes possible to induce a job performance that increases the firm’s profits.
Example: Microsoft
Slide: 15
The Principal-Agent Problem
Incentive pay
Pay related to performance - are very common.
Based on a variety of performance criteria such as profits or production or sales targets.
Slide: 16
The Principal-Agent Problem
Well-specified contracts
Long-term contracts tie the long-term fortunes of managers and workers (agents) to the success of the principle(s) - the owner(s) of the firm, when the contract includes ownership features.
Short-term contracts can work as well when the contract is specified on the basis of the completion of specific tasks within specific time-periods
Note however, that specific contracts are costly (information, negotiation. Etc) to draw and are often too restrictive.
Slide: 17
The Types of Business Organisation
Sole Proprietorship a firm with a single owner
Partnership a firm with two or more owners who have unlimited
liability
Company a firm owned by one or more limited liability
stockholders
Slide: 18
The Pros and Cons of the Different Types of Firms
Proprietorship
Pros
Easy to set up
Simple decision making
Slide: 19
The Pros and Cons of the Different Types of Firms
Proprietorship
Cons
Capital is expensive
Bad decision not checked by need for consensus
Owners entire wealth at risk
Ability to grow is restricted by availability to capital
Firm dies with owner
Slide: 20
The Pros and Cons of the Different Types of Firms
Partnership
Pros
Easy to set up
Diversified decision making
Can survive withdrawal of partner
Slide: 21
The Pros and Cons of the Different Types of Firms
Partnership
Cons
Achieving consensus may be slow and expensive
Owners entire wealth at risk
Withdrawal of partner may create capital shortage
Capital is expensive
Slide: 22
The Pros and Cons of the Different Types of Firms
Company
Pros
Owners have limited liability
Large-scale, low-cost capital available
Professional management not restricted by ability of owners
Perpetual life
Long-term labour contracts cut labour costs
Slide: 23
The Pros and Cons of the Different Types of Firms
Company
Cons
Complex management structure can make decision-making slow and expensive
Divorce of ownership and control highlights principal-agent problem
Slide: 24
Markets and the Competitive Environment
Economists identify four market types:
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
Slide: 25
Markets and the Competitive Environment
Perfect competition
Arises when there are many firms each selling an identical product, many buyers, and no restrictions on the entry of new firms into the industry.
Slide: 26
Markets and the Competitive Environment
Monopolistic competition
A market structure in which a large number of firms compete by making similar buy slightly different products.
Product differentiation gives a monopolistically competitive firm an element of monopoly power.
Slide: 27
Markets and the Competitive Environment
Oligopoly
A market structure in which a small number of firms compete.
Slide: 28
Markets and the Competitive Environment
Monopoly
An industry that produces a good or service for which no close substitutes exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.
Slide: 29
Markets and the Competitive Environment
Concentration is an indicator variable for market power, but it is not a sufficient indicator
The Concentration Ratio Measures the percentage of the value of sales
accounted for by the four largest firms Range from 0 percent to 100 percent
Three-firm concentration ratio: measures the percentage of the value of sales
accounted for by the three largest firms in a market
Slide: 30
Markets and the Competitive Environment
Three problems in the calculation and interpretation of concentration ratios
Market definition
Barriers to entry
Structure versus behaviour
Slide: 31
Market Structure
Characteristics competition competition Oligopoly Monopoly
Number of firms Many Many Few Onein market
Product Identical Differentiated Either identical No close or differentiated substitute
Barriersto entry None None Moderate High
Firm’s control None Some Considerable Considerableover price or regulated
Concentration ratio 0 Low High 100
Examples Wheat, meat office cleaning Automobiles, Local water car repairs chocolate bars distribution,
Perfect Monopolistic
Slide: 32
Firms and Markets
What determines whether markets or firms coordinate production?
Answer:Answer: Whichever is the economically efficient method.
Slide: 33
Why Firms?
Why firms are sometimes more efficient coordinators of economic activity?
Lower transactions costs
Economies of scale
Economies of scope
Economies of team production
Slide: 34
Why Firms?
Transactions costs The costs arising from finding someone with whom to
do business, of reaching an agreement about the price and other aspects of the exchange, and of ensuring that the terms of the agreement are fulfilled.
Coase and The Nature of the Firm
Slide: 35
Why Firms?
Economies of scale exist when the cost of producing a unit of a good falls as output increases.
Economies of scope exist when a firm uses specialised resources to produce a range of goods and services.
Team production A production process in which the individuals in a group
specialise in mutually supportive tasks.
Slide: 36
The Firm’s Time Horizon
The Short Run and the Long Run The short run is a period of time in which the quantity
of at least one input is fixed and the quantities of the other inputs can be varied. variable inputs and fixed inputs
The long run is a period of time in which the quantities of all inputs can be varied. The firm’s size can be selected
Slide: 37
Short-Run Technology Constraint
Increasing output in the short-run firms must increase the quantity of Labour
Total product is the total output produced.
Marginal product is the increase in total product that result from a one-unit increase in an input.
Average product is the total product divided by the quantity of inputs.
Slide: 38
Total Product, Marginal Product, and Average Product
Total Marginal Average Labour product product product (workers (hamburgers (hamburgers per (hamburgers per hour) per hour) additional worker) per worker)
a 0 0
b 1 25
c 2 60
d 3 80
e 4 90
f 5 95
Slide: 39
Total Product, Marginal Product, and Average Product
Total Marginal Average Labour product product product (workers (hamburgers (hamburgers per (hamburgers per hour) per hour) additional worker) per worker)
a 0 0
b 1 25
c 2 60
d 3 80
e 4 90
f 5 95
25
35
20
10
5
Slide: 40
Total Product, Marginal Product, and Average Product
Total Marginal Average Labour product product product (workers (hamburgers (hamburgers per (hamburgers per hour) per hour) additional worker) per worker)
a 0 0 -
b 1 25 25.00
c 2 60 30.00
d 3 80 26.67
e 4 90 22.50
f 5 95 19.00
25
35
20
10
5
Slide: 41
Attainable
Total Product Curve
0 1 2 3 4 5Labor (workers per day)
5
10
15TP
Unattainable
a
b
c
d
e fO
utpu
t (ha
mbu
rger
s pe
r ho
ur)
Slide: 42
Marginal Product Curve
Marginal product is also measured by the slope of the total product curve.
Increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal product of the previous worker.
Slide: 43
Marginal Product Curve
Diminishing marginal returns Occur when the marginal product of an additional
worker is less than the marginal product of the previous worker
Law of diminishing returns As a firm uses more of a variable input, with a given
quantity of fixed inputs, the marginal product of the variable input eventually diminishes
Slide: 44
Marginal Product
Labour (workers per hour)
c
TP
Out
put (
ham
burg
ers
per
hour
)
Labour (workers per hour)
Mar
gina
l pro
duct
(ham
burg
ers
per
hour
per
wor
ker)
MP
d
The red highlightsthe point of diminishing returns
0 1 2 3 4 5
60
90
25
80
95
0 1 2 3 4 5
5
15
10
25
20
30
35
ef
Slide: 45
Average Product Curve
What does the average productWhat does the average product
curve look like?curve look like?
Remember that Marginals drag Remember that Marginals drag Averages!Averages!
Marginal grades in this course will Marginal grades in this course will influence where your average grade influence where your average grade
for the course isfor the course is
Slide: 46
Average Product
MP
AP
c
d
e
f
Maximumaverageproduct
Labour (workers per hour)0 1 2 3 4 5
5
15
10
25
20
30
35
26.67b
Mar
gina
l pro
duct
(ham
burg
ers
per
hour
per
wor
ker)
a
Slide: 47
Short-Run Cost
Total cost (TC) is the cost of all productive resources used by a firm.
Total fixed cost (TFC) is the cost of all the firm’s fixed inputs.
Total variable cost (TVC) is the cost of all the firm’s variable inputs.
Slide: 48
Short-Run Cost
Total cost (TC) is the cost of all productive resources used by a firm.
TC = TFC + TVC
TC TFC TVC
Q Q Q= +
OR ATC = AFC + AVC
Slide: 49
Total Cost Curves
Total Totalfixed variable Totalcost cost cost
Labour Output (TFC) (TVC) (TC)(workers (hamburgersper hour) per hour) (dollars per hour)
a 0 0
b 1 25
c 2 60
d 3 80
e 4 90
f 5 95
Slide: 50
Total Cost Curves
Total Totalfixed variable Totalcost cost cost
Labour Output (TFC) (TVC) (TC)(workers (hamburgersper hour) per hour) (dollars per hour)
a 0 0 25
b 1 25 25
c 2 60 25
d 3 80 25
e 4 90 25
f 5 95 25
Slide: 51
Total Cost Curves
Total Totalfixed variable Totalcost cost cost
Labour Output (TFC) (TVC) (TC)(workers (hamburgersper hour) per hour) (dollars per hour)
a 0 0 25 0
b 1 25 25 20
c 2 60 25 40
d 3 80 25 60
e 4 90 25 80
f 5 95 25 100
Slide: 52
Total Cost Curves
Total Totalfixed variable Totalcost cost cost
Labour Output (TFC) (TVC) (TC)(workers (hamburgersper hour) per hour) (dollars per hour)
a 0 0 25 0 25
b 1 25 25 20 45
c 2 60 25 40 65
d 3 80 25 60 85
e 4 90 25 80 105
f 5 95 25 100 125
Slide: 53
TC
TVC
Total Cost Curves
TFC
TC = TFC + TVC
Output (hamburgers per hour)
Cos
t (do
llars
per
hou
r)
0 20 40 60 80 100
50
100
140
25
Slide: 54
Marginal Cost
Marginal cost is the increase in total cost that results from a one-unit increase in output.
It equals the increase in total cost divided by the increase in output.
Marginal costs decrease at low outputs because of the gains from specialisation, but it eventually increases due to the law of diminishing returns.
Slide: 55
Average Cost
Average fixed cost (AFC) is total fixed cost per unit of output.
Average variable cost (AVC) is total variable cost per unit of output.
Average total cost (ATC) is total cost per unit of output.
Slide: 56
Marginal Cost and Average Costs Total Total Average Average
fixed fixed Total Marginal fixed variable Total
cost cost cost cost cost cost cost
Labor Output (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC)
(workers (hamburgers (cents per
per hour) per hour (dollars per hour) additional hamburgers) (cents per hamburgers)
a
b
c
d
e
f
0
1
2
3
4
5
0
25
60
80
90
95
25
25
25
25
25
25
0
20
40
60
80
100
25
45
65
85
105
125
—
100
42
31
28
26
—
80
67
75
89
105
—
180
108
106
117
132
80
57
100
200
400
Slide: 57
Marginal Cost and Average Costs
Output (hamburgers per hour)
Cos
t (ce
nts
per
ham
burg
er) ATC = AFC + AVC
100
150
250
50
0 20 40 60 80 100
200
AVC
MC
ATC
AFC
Slide: 58
Long-Run Cost
Long-run cost The cost of production when a firm uses the
economically efficient quantities of labour and capital.
Long-run costs are affected by the production function.
Production function The relationship between the maximum output
attainable and the quantities of both Labour an Capital and the available state of technology.
Slide: 59
The Long-Run Average Cost Curve
The long run average total cost curve is derived from the short-run average total cost curves.
The segment of the short-run average total cost curves along which average total cost is the lowest make up the long-run average total cost curve.
Slide: 60
Fast Food
Long-Run Average Cost Curve
Output (hamburgers per hour)
Ave
rage
cos
t (do
llars
per
ham
burg
er)
b
0 60 120 180 200 240
Factory
Deli
a
c
LRAC Curve
Slide: 61
Economies and Diseconomies of Scale
Returns to scale are the increases in output that result from increasing all inputs by the same percentage.
Three possibilities:
Constant returns to scale
Increasing returns to scale
Decreasing returns to scale
Slide: 62
Returns to Scale
Constant returns to scale
Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by the same percentage
Slide: 63
Returns to Scale
Increasing returns to scale
Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by a larger percentage
Slide: 64
Returns to Scale
Decreasing returns to scale
Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by a smaller percentage
Slide: 65
Constantreturns toscale
Increasingreturns toscale
SRACa
Output
Ave
rage
cos
t
Economies of ScaleLRAC
SRACb
Qo Q1Q2
Decreasing returns toscale
Slide: 66
Long-Run Costs
In the long-run all costs are variable because short-run fixed costs can be adjusted. So, the long-run average cost curve is the lower envelope of all the short run average cost curves
C
Q
ATC LRAC