The Costs of Production 1 22 C H A P T E R Costs exist because resources Are scarce Productive Have...
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The Costs of Production 1 22 C H A P T E R
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Transcript of The Costs of Production 1 22 C H A P T E R Costs exist because resources Are scarce Productive Have...
The Costs of Production1
22C H A P T E R
Costs exist because resources
• Are scarce• Productive• Have alternative uses
• Use of a resource in a specific use implies an economic or opportunity cost
2
Explicit and implicit costs
• Explicit costs: payments for the use of resources owned by others.
• Implicit costs: payments that self-employed resources could have earned in their best alternative use.
3
Economic costs• The payment the firm must make or income it must
provide to attract resources away from alternative production opportunities.
• Normal profit as a cost Implicit costs are a normal profit:• Foregone wages• Foregone interest• Foregone rent• Foregone entrepreneurial income
4
• Example:• Your salary: 22000 a year• Open your own business: • Invest your savings: 20000• The saving earn 1000 per year• Rent a store you own: 5000 per year• Hire an employee: 18000 a year
5
• After 1 year:• Total sale revenue ………………………..….120,000• costs of t-shirts ………….40,000• worker salary …………….18,000• rent …………………………..5,000
• Total (explicit) costs …………63,000
• Accounting profits ………………………...57,000
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• Accounting profit ……………….………….….57,000• forgone interest ……………...1,000 • forgone rent …………………...5,000• forgone wages ………….…….22,000• forgone entrepreneurial income….5,000
• Total implicit costs ………………33,000
• Economic Profits ………………………………..24,000
7
Economic profit
• Economic profit is = Total revenue – economic costs
OrTotal revenue – (explicit + implicit costs)
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Example• Hamad is working as a manager for 22000. his talent
worth 5000. He decides to open his own business. • He invested his 20000 of savings that earn 1000• The new firm will occupy a store he used to let out for
5000.• He hired labor for 18000• Cost of raw materials is 40000 and other utilities is
5000.• Total revenue is 120000• Calculate the explicit and implicit costs• Calculate the accounting and economic profits.
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EconomicProfit
Implicit costs(including a
normal profit)
ExplicitCosts
Accountingcosts (explicit
costs only)
AccountingProfit
Ec
on
om
ic (
op
po
rtu
nit
y) C
os
ts
TOTAL
REVENUE
Profits to anEconomist
Profits to anAccountant
ECONOMIC COSTS
10
SHORT RUN AND LONG RUN
Accounting: Short and long run is based upon annual chronology
Economics:Short run has fixed plant capacity sizeLong run has variable plant capacity size
11
Average Product (AP)
Total Product (TP)Marginal Product (MP)
SHORT-RUN PRODUCTIONRELATIONSHIPS
Marginal Product =Change in Total Product
Change in Labor Input
Average Product =Total Product
Units of Labor12
Variable resource (labor)
Total product
Marginal product
Average product
Comments
0 0 -
1 10 10 10 Increasing marginal returns
2 25 15 12.5 Increasing marginal returns
3 45 20 15 Increasing marginal returns
4 60 15 15 Diminishing marginal returns
5 70 10 14 Diminishing marginal returns
6 75 5 12.5 Diminishing marginal returns
7 75 0 10.71 Diminishing marginal returns
8 70 -5 8.75 Negative marginal returns
Law of diminishing marginal returns As successive units of a variable resource
are added to a fixed resource, beyond some point, the extra, or marginal product that can be attributed to each additional unit of the variable resource will decline
WHY?
14
Law of Diminishing Returns
SHORT-RUN PRODUCTIONRELATIONSHIPS
To
tal P
rod
uct
, TP
Quantity of Labor
Ave
rag
e P
rod
uct
, AP
, an
dm
arg
inal
pro
du
ct, M
P
Quantity of Labor
Total Product
MarginalProduct
AverageProduct
IncreasingMarginalReturns
15
Law of Diminishing Returns
SHORT-RUN PRODUCTIONRELATIONSHIPS
To
tal P
rod
uct
, TP
Quantity of Labor
Ave
rag
e P
rod
uct
, AP
, an
dm
arg
inal
pro
du
ct, M
P
Quantity of Labor
Total Product
MarginalProduct
AverageProduct
DiminishingMarginalReturns
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Law of Diminishing Returns
SHORT-RUN PRODUCTIONRELATIONSHIPS
To
tal P
rod
uct
, TP
Quantity of Labor
Ave
rag
e P
rod
uct
, AP
, an
dm
arg
inal
pro
du
ct, M
P
Quantity of Labor
Total Product
MarginalProduct
AverageProduct
NegativeMarginalReturns
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Fixed CostsTotal Fixed Costs
Average Fixed Costs =Total Fixed Costs
Quantity
Variable CostsTotal Variable Costs
Average Variable Costs =Total Variable Costs
Quantity
SHORT-RUN PRODUCTION COSTS
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Total CostTotal Fixed and Variable Costs
Average Total Cost =Total Costs
Quantity
Marginal Cost
Total Variable Costs
Marginal Cost =Change in Total Costs
Change in Quantity
SHORT-RUN PRODUCTION COSTS
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Total Product Total Fixed Costs Total Variable Costs Total Costs
0 100 0 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030
Total Product
Average Fixed Costs Average Variable Costs
Average Total Costs
Marginal Costs
0
1 100 90 190 90
2 50 85 135 80
3 33.33 80 113.33 70
4 25 75 100 60
5 20 74 94 70
6 16.67 75 91.67 80
7 14.29 77.14 91.43 90
8 12.50 81.25 93.75 110
9 11.11 86.67 97.78 130
10 10 93 103 150
Marginal Cost = MC
Total Fixed Costs = TFCTotal Variable Costs = TVC
Average Variable Costs = AVC
Total Costs = TC
Average Total Costs = ATC
Average Fixed Costs = AFC
Summary of DefinitionsSHORT-RUN PRODUCTION COSTS
22
SHORT-RUN COSTS GRAPHICALLY
Quantity
Co
sts
(do
llar
s)
TC
TotalCost
Fixed CostTVC
Variable Cost
TFC
Combining TVCWith TFC to get
Total Cost
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SHORT-RUN COSTS GRAPHICALLY
Quantity
Co
sts
(do
llar
s)
AFC
AVCATC
MC
Plotting Average andMarginal Costs
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PRODUCTIVITY AND COST CURVES
Co
sts
(d
olla
rs)
Ave
rag
e p
rod
uct
an
dm
arg
inal
pro
du
ctQuantity of labor
Quantity of output
MPAP
MCAVC
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LONG-RUN PRODUCTION COSTS
All such plant capacitiescan be plotted...
For every plant capacity size...There is a short-run ATC curve
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LONG-RUN PRODUCTION COSTS
Un
it C
ost
s
Output
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LONG-RUN PRODUCTION COSTS
Un
it C
ost
s
Output
28
LONG-RUN PRODUCTION COSTS
The Long-run ATC just “envelopes”all of the short-run ATC curves
Un
it C
ost
s
Output
29
LONG-RUN PRODUCTION COSTS
Un
it C
ost
s
Output
Long-run ATC
30
ECONOMIES ANDDISECONOMIES OF SCALE
Un
it C
ost
s
Output
Long-run ATC
Economiesof scale
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ECONOMIES ANDDISECONOMIES OF SCALE
Un
it C
ost
s
Output
Long-run ATC
Economiesof scale
Constant returnsto scale
32
ECONOMIES ANDDISECONOMIES OF SCALE
Un
it C
ost
s
Output
Long-run ATC
Economiesof scale
Diseconomiesof scale
Constant returnsto scale
33
Economies of scale
• Labor specialization: working at fewer tasks workers become efficient in them. Greater labor specialization eliminates the loss of time that accompanies each shift of a worker from one task to another
• Managerial specialization: small firms can’t use management specialists to best advantages. Large companies can use specialists full time, which means greater efficiency and lower costs
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Economies of scale
• Efficient capital. Large firms can afford the most efficient equipments, these requires high volume of production and large scale producers, e.g., car robots.
• Other factors: design and development and other startup costs,
35
Diseconomies of scale
• The main reason is difficulty of efficiently controlling and coordinating a firms operation when it becomes large.
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Constant returns of scale
• Effect of factors of economies and factors of diseconomies is equal.
• Minimum efficient size:The lowest level of output at which a firm can minimize long run average costs.
37
ECONOMIES ANDDISECONOMIES OF SCALE
Un
it C
ost
s
Output
Long-run ATC
Where extensive economies ofscale exist: Natural Monopolies.
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ECONOMIES ANDDISECONOMIES OF SCALE
Un
it C
ost
s
Output
Long-run ATC
Where economies of scale are quickly
exhausted
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Chapter Conclusions
Natural Monopoly
MINIMUM EFFICIENT SCALEAND INDUSTRY STRUCTURE
Minimum Efficient Scale -
MES
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economic (opportunity) costexplicit costsimplicit costsnormal profiteconomic profitshort runlong runtotal product (TP)marginal product (MP)average product (AP) law of diminishing returnsfixed costs
variable coststotal costaverage fixed cost (AFC)average variable cost (AVC)average total cost (ATC)marginal cost (MC)economies of scalediseconomies of scaleconstant returns to scaleminimum efficient scalenatural monopoly
41ENDBACKCopyright McGraw-Hill/Irwin 2002
