Chapter 9

Businesses and the Costs of Produc2on

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9-2

Economic Costs

The payment that must be made to obtain and retain the services of a resource

Explicit costs Monetary outlay

Implicit costs Opportunity cost of using self-owned resources

Value of next-best use Includes a normal prot

LO1

9-3

Accounting Profit and Normal Profit

Accoun2ng prot = Total revenue explicit costs Economic prot = AccounFng prot implicit costs Economic prot (to summarize) = Revenue economic cost = Revenue explicit costs implicit costs

LO1

9-4

Explicit costs

Accoun2ng costs (explicit costs

only)

Implicit costs (including a

normal prot)

Economic prot

Accoun2ng prot

Econ

omic

(opp

ortunity)

costs

Total reven

ue

LO1

Economic Profit

9-5

Short Run and Long Run

Short run Some variable inputs Fixed plant

Long run All inputs are variable Firms can adjust plant size as well as enter and exit industry

LO2

9-6

Short Run Production Relationships

Total product (TP) Marginal product (MP)

Average product (AP)

LO2

Marginal product change in total product change in labor input

=

Average product total product units of labor

=

9-7

Law of Diminishing Returns

Law of diminishing returns Resources are of equal quality Technology is xed Variable resources are added to xed resources

At some point, marginal product will fall RaFonale

LO2

9-8

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

(1) Units of the Variable Resource (Labor)

(2) Total Product (TP)

(3) Marginal Product

(MP) Change in (2)/ Change in (1)

(4) Average Product

(AP), (2)/(1)

0 0 -

1 10 10 Increasing marginal returns

10.00

2 25 15 12.50

3 45 20 15.00

4 60 15 Diminishing marginal returns

15.00

5 70 10 14.00

6 75 5 12.50

7 75 0 10.71

8 70 -5 NegaFve marginal returns

8.75

7-8

The Law of Diminishing Returns

9-9

The Law of Diminishing Returns

TP

MP

AP

Increasing Marginal Returns

Diminishing Marginal Returns

Nega2ve Marginal Returns

1 2 3 4 5 6 7 8 9 0

10

20

30 To

tal p

rodu

ct, TP

1 2 3 4 5 6 7 8 9

20

10

Margina

l produ

ct, M

P

LO2

9-10

Short Run Production Costs

Fixed costs (TFC) Costs that do not vary with output

Variable costs (TVC) Costs that do vary with output

Total cost (TC) Sum of TFC and TVC TC = TFC + TVC

LO3

9-11

Costs

1 2 3 4 5 6 7 8 9 10 0 Q

100

200

300

400

500

600

700

800

900

1000

$1100

TFC

TC

TVC

Total cost

Variable cost

Fixed cost

LO3

Short-Run Production Costs

9-12

Per-Unit, or Average, Costs

Average xed cost AFC = TFC/Q Average variable cost AVC = TVC/Q Average total cost ATC = TC/Q Marginal cost MC = TC/Q

LO3

9-13

Short-Run Production Costs

LO3

Total, Average, and Marginal Cost Schedules for an Individual Firm in the Short Run

Total Cost Data Average Cost Data Marginal Cost

(1) Total Product

(Q)

(2) Total Fixed Cost

(TFC)

(3) Total Variable

Cost (TVC)

(4) Total Cost (TC) TC=TFC+TVC

(5) Average Fixed

Cost (AFC)

AFC = TFC/Q

(6) Average Variable Cost (AVC)

AVC=TVC/Q

(7) Average Total

Cost (ATC)

ATC = TC/Q

(8) Marginal Cost

(MC) MC =TC/Q

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

7-13

9-14

Per-Unit, or Average, Costs

Costs

1 2 3 4 5 6 7 8 9 10 0 Q

50

100

150

$200

AFC

ATC AVC

AVC

AFC

LO3

9-15

Marginal Cost

Costs

1 2 3 4 5 6 7 8 9 10 0 Q

50

100

150

$200

AFC

MC

ATC AVC

AVC

AFC

LO3

9-16

Marginal Cost and Marginal Product

Average prod

uct a

nd

margina

l produ

ct

Cost (d

ollars)

MP AP

MC AVC

Quan2ty of output

Quan2ty of labor

Cost curves LO3

9-17

Long Run Production Costs

The rm can change all input amounts, including plant size

All costs are variable in the long run Long run ATC

Dierent short run ATCs

LO4

9-18

Firm Size and Costs Av

erage total costs ATC-1

ATC-2

ATC-3 ATC-4

ATC-5

Output

LO4

9-19

The Long-Run Cost Curve

Long-run ATC

Average total costs ATC-1

ATC-2

ATC-3 ATC-4

ATC-5

Output

LO4

9-20

Economies of Scale

Economies of scale Labor specializaFon Managerial specializaFon Ecient capital Other factors

Constant returns to scale

LO4

9-21

Diseconomies of Scale

Diseconomies of scale Control and coordinaFon problems CommunicaFon problems Worker alienaFon Shirking

LO4

9-22

MES and Industry Structure

Minimum ecient scale (MES) Lowest level of output at which long run average costs are minimized

Can determine the structure of the industry Natural monopoly

Long run costs are minimized when one rm produces the product

LO4

9-23

MES and Industry Structure

Output

Average total costs

Long-run ATC

Economies of scale

Constant returns to scale

Diseconomies of scale

q1 q2

LO5

9-24

MES and Industry Structure

Output

Average total costs

Economies of scale

Diseconomies of scale

Long-run ATC

LO5

9-25

MES and Industry Structure

Output

Average total costs

Long-run ATC

Economies of scale

Diseconomies of scale

LO5