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 10 10 25 15 45 20 60 15 70 10 75 75 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 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) $100 $0 $100 100 90 190 $100.00 $90.00 $190.00 $90 100 170 270 50.00 85.00 135.00 80 100 240 340 33.33 80.00 113.33 70 100 300 400 25.00 75.00 100.00 60 100 370 470 20.00 74.00 94.00 70 100 450 550 16.67 75.00 91.67 80 100 540 640 14.29 77.14 91.43 90 100 650 750 12.50 81.25 93.75 110 100 780 880 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 ... 11 3.33 70 10 0 300 400 25.00 75.00 10 0.00 60 10 0 370 470 20.00 74.00 94.00 70 10 0 450 550 16 .67 75.00 91. 67 80 10 0 540 640 14 .29 77 .14 91. 43 90 10 0 650 750 12 .50 81. 25 93.75 11 0 10 0 780 880 11 .11 86.67... Product (TP) 0 10 10 25 15 45 20 60 15 70 10 75 75 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... (1) Total Product (Q) (2) Total Fixed Cost (TFC) (3) Total Variable Cost (TVC) $10 0 $0 $10 0 10 0 90 19 0 $10 0.00 $90.00 $19 0.00 $90 10 0 17 0 270 50.00 85.00 13 5.00 80 10 0 240 340 33.33 80.00 11 3.33