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micro economics chapter 09 1

9
Businesses and the Costs
of Production

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.






LO1

Economic Costs
The payment that must be made to
obtain and retain the services of a
resource
Explicit Costs
• Monetary payments, often uses check

Implicit Costs
• Value of next best use
• What the firm gives up
• Includes normal profit





LO1

Economic Costs
Normal profit
• Minimum payment required to remain
engaged in current enterprise.
Economic profit means firm is earning a
normal profit.


Accounting Profit and Normal
Profit

• Accounting profit


LO1

= Revenue – Explicit Costs
Economic profit
= Revenue – Explicit - Implicit Costs


Short Run and Long Run

• Short Run
• Some variable inputs
• Fixed plant
• Long Run
• All inputs are variable
• Variable plant


• Firms enter and exit
LO1


Short-Run Production
Relationships

• Total Product (TP)
• Marginal Product (MP)
Change in Total Product
Marginal Product =
Change in Labor Input

• Average Product (AP)
Average Product

LO2

=

Total Product
Units of Labor


Law of Diminishing Marginal
Returns

• Resources are of equal quality
• Technology fixed
• Variable resources are added to fixed


LO2

resources
At some point, marginal product will
fall


The Law of Diminishing Returns
Table 7.1 Total, Marginal, and Average Product: The Law of Diminishing Returns

LO2

(1)
Units of the
Variable
Resource
(Labor)

(3)
Marginal
Product (MP)
Change in (2)/
Change in (1)

(2)
Total Product
(TP)

0

0

1

10

10

2

25

15

3

45

20

4

60

15

5

70

10

6

75

5

7

75

0

8

70

-5

(4)
Average Product
(AP),
(2)/(1)
Increasing
marginal
returns

10.00
12.50
15.00
15.00

Diminishing
marginal
returns

14.00
12.50
10.71

Negative
marginal
returns

8.75


Short-Run Production Costs

• Fixed Costs (TFC)
• Costs do not vary with output
• Variable Costs (TVC)
• Costs vary with output
• Total Costs (TC)
• TC = TFC + TVC

LO3


Per-Unit, or Average, Costs

• Average Fixed Costs
• Average Variable Costs
• Average Total Costs
• Marginal Costs

LO3

AFC = TFC/Q
AVC = TVC/Q
ATC = TC/Q
MC = ΔTC/ΔQ


Short-Run Production Costs
Table 7.2 Total, Average, and Marginal Cost Schedules for an Individual Firm in the Short Run

Total Cost Data

Average Cost Data

Marginal
Cost

(7)
Average
Total Cost
(ATC)

(8)
Marginal
Cost
(MC)

(4)
Total Cost
(TC)

(5)
Average
Fixed Cost
(AFC)

(6)
Average
Variable
Cost
(AVC)

TC=TFC+TVC

AFC = TFC/Q

AVC=TVC/Q

ATC = TC/Q

MC =ΔTC/ΔQ

(1)
Total
Product
(Q)

(2)
Total Fixed
Cost
(TFC)

(3)
Total
Variable
Cost
(TVC)

0

$100

$0

$100

1

100

90

190

$100.00

$90.00

$190.00

$90

2

100

170

270

50.00

85.00

135.00

80

3

100

240

340

33.33

80.00

113.33

70

4

100

300

400

25.00

75.00

100.00

60

5

100

370

470

20.00

74.00

94.00

70

6

100

450

550

16.67

75.00

91.67

80

7

100

540

640

14.29

77.14

91.43

90

8

100

650

750

12.50

81.25

93.75

110

9

100

780

880

11.11

86.67

97.78

130

10

100

930

1030

10.00

93.00

103.00

150

LO3


Long-Run Production Costs

• The firm can change all input



LO4

amounts, including plant size.
All costs are variable in the long run.
Long run ATC
• Each point reflects the lowest
possible ATC for that output level


Economies and Diseconomies of
Scale

• Economies of scale: downward sloping
portion of LR-ATC
• Increase in resources, output increases
more than proportionately
• Labor specialization
• Managerial specialization
• Efficient capital
• Other factors
LO4


Economies and Diseconomies of
Scale

• Constant returns to scale: horizontal


LO4

portion of LR-ATC
Diseconomies of scale: upslopint portion
of LR-ATC
• Control and coordination problems
• Communication problems
• Worker Alienation
• Shirking


MES and Industry Structure

• Minimum Efficient Scale (MES) is
• Lowest level of output where long
run average costs are minimized
• Can determine the structure of the
industry.

LO4


Applications and Illustrations

• Rising gasoline prices
• Successful start-up firms
• Verson stamping machine
• The daily newspaper
• Aircraft and concrete plants

LO3



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