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The Costs of Production Chp: 8 Lecture: 15 & 16

The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

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Page 1: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

The Costs of ProductionChp: 8

Lecture: 15 & 16

Page 2: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Economic CostsEqual to opportunity costsExplicit + implicit costsExplicit costs

Monetary paymentsImplicit costs

Value of next best useSelf-owned resourcesSelf-employed resources

8-2

Page 3: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Profit

Accounting profitTotal revenue less explicit cost

Normal profitEqual to implicit cost

Economic or pure profitTotal revenue less economic cost

8-3

Page 4: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Profits Compared

EconomicProfit

AccountingCosts (Explicit

Costs Only)

AccountingProfit

ExplicitCosts

Implicit Costs(Including

Normal Profit)

Eco

no

mic

(Op

po

rtu

nit

y)C

ost

s

To

tal

Rev

enu

e

Economic Accounting

8-4

Page 5: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Short and Long Run

The short runFixed plant capacityVariable intensity of plant useVariable output

The long run Variable plant capacityFirms enter and exit

8-5

Page 6: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Production Relationships

Total product (TP) Marginal product (MP) Average product (AP)

Average Product Total Product

Units of Labor=

Marginal ProductChange in Total Product

Change in Labor Input=

8-6

Page 7: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Law of Diminishing Returns

Fixed technologyAdd variable resource to fixed resource

Marginal product will declineBeyond some point

Rationale

8-7

Page 8: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

IncreasingMarginalReturns

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)

(3)AverageProduct

(AP),(2)/(1)

012345678

01025456070757570

1015201510

50

-5

-10.0012.5015.0015.0014.0012.5010.71 8.75

]]]]]]]]

DiminishingMarginalReturns

NegativeMarginalReturns

8-8

Page 9: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

0

10

20

30

To

tal P

rod

uct

, TP

1 2 3 4 5 6 7 8 9

20

10

Mar

gin

al P

rod

uct

, MP

1 2 3 4 5 6 7 8 9

TP

MP

AP

IncreasingMarginalReturns

DiminishingMarginalReturns

NegativeMarginalReturns

Law of Diminishing Returns

8-9

Page 10: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Short-Run Production Costs

Fixed CostsDo not vary with output

Variable CostsMaterials, most labor

Total CostTC = TFC + TVC

8-10

Page 11: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Per-Unit Production Costs

Average fixed cost AFC = TFC/Q

Average variable costAVC = TVC/Q

Average total cost ATC = TC/Q = TFC/Q + TVC/QATC = AFC+AVC

Marginal costMC = change in TC/change in Q 8-11

Page 12: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Short-Run Production Costs

Co

sts

1 2 3 4 5 6 7 8 9 100 Q

100

200

300

400

500

600

700

800

900

1000

$1100

TFC

TC

TVC

TotalCost

VariableCost

FixedCost

8-12

Page 13: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Short-Run Production Costs

Co

sts

1 2 3 4 5 6 7 8 9 100 Q

50

100

150

$200

AFC

MC

ATCAVC

AVC

AFC

8-13

Page 14: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Production RelationshipsMarginal cost and diminishing returnsMarginal cost and marginal productMarginal cost and average variable cost

Marginal cost and average total costProduction curves and cost curvesShifts in cost curves

8-14

Page 15: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Ave

rag

e P

rod

uct

an

dM

arg

inal

Pro

du

ctC

ost

(D

olla

rs)

Graphical Relationships

MPAP

MCAVC

Quantity of Output

Quantity of Labor

Production Curves

Cost Curves

8-15

Page 16: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Long-Run Production Costs

Choose your plant sizeMinimize ATCDifferent ATC curves

Short runLong run ATC

Envelope of short run ATC

8-16

Page 17: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Long-Run ATC Curve

Ave

rag

e T

ota

l C

ost

sATC-1

ATC-2

ATC-3 ATC-4

ATC-5

Output

Any number of short-run optimum size cost curves can be constructed

8-17

Page 18: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Long-Run ATC Curve

Long-RunATC

Ave

rag

e T

ota

l C

ost

sATC-1

ATC-2

ATC-3 ATC-4

ATC-5

Output

The long-run ATC curve just“envelopes” the short run ATCs

8-18

Page 19: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Long Run Production Cost

Economies of ScaleLabor specializationManagerial specializationEfficient capital

Diseconomies of ScaleConstant Returns to Scale

8-19

Page 20: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Long-Run ATC Shapes

Output

Long-run ATC curve where economiesof scale exist

Ave

rag

e T

ota

l C

ost

s

Long-RunATC

EconomiesOf Scale

Constant ReturnsTo Scale

DiseconomiesOf Scale

q1 q2

8-20

Page 21: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Output

Long-run ATC curve where costs arelowest only when large numbers areparticipating

Ave

rag

e T

ota

l C

ost

sEconomies

Of ScaleDiseconomies

Of Scale

Long-RunATC

Long-Run ATC Shapes

8-21

Page 22: The Costs of Production Chp: 8 Lecture: 15 & 16. Economic Costs Equal to opportunity costs Explicit + implicit costs Explicit costs Monetary payments

Output

Long-run ATC curve where economiesof scale exist, are exhausted quickly,and turn back up substantially

Ave

rag

e T

ota

l C

ost

s

Long-RunATC

EconomiesOf Scale

DiseconomiesOf Scale

Long-Run ATC Shapes

8-22


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