1、 2009 South-Western,a part of Cengage Learning,all rights reservedC H A P T E REconomicsPremium PowerPoint Slides by Ron Cronovich13You run General Motors.List 3 different costs you have.List 3 different business decisions that are affected by your costs.1What is a production function?What is margin
2、al product?How are they related?What are the various costs,and how are they related to each other and to output?How are costs different in the short run vs.the long run?What are“economies of scale”?2THE COSTS OF PRODUCTION3Total Revenue,Total Cost,ProfitWe assume that the firms goal is to maximize p
3、rofit.Profit =Total revenue Total costthe amount a firm receives from the sale of its outputthe market value of the inputs a firm uses in productionTHE COSTS OF PRODUCTION4Costs:Explicit vs.ImplicitExplicit costs require an outlay of money,e.g.,paying wages to workers.Implicit costs do not require a
4、 cash outlay,e.g.,the opportunity cost of the owners time.Remember one of the Ten Principles:The cost of something is what you give up to get it.This is true whether the costs are implicit or explicit.Both matter for firms decisions.THE COSTS OF PRODUCTION5Explicit vs.Implicit Costs:An ExampleYou ne
5、ed$100,000 to start your business.The interest rate is 5%.Case 1:borrow$100,000explicit cost=$5000 interest on loanCase 2:use$40,000 of your savings,borrow the other$60,000explicit cost=$3000(5%)interest on the loanimplicit cost=$2000(5%)foregone interest you could have earned on your$40,000.In both
6、 cases,total(exp+imp)costs are$5000.THE COSTS OF PRODUCTION6Economic Profit vs.Accounting ProfitAccounting profit=total revenue minus total explicit costsEconomic profit=total revenue minus total costs(including explicit and implicit costs)Accounting profit ignores implicit costs,so its higher than
7、economic profit.The equilibrium rent on office space has just increased by$500/month.Compare the effects on accounting profit and economic profit ifa.you rent your office spaceb.you own your office space7The rent on office space increases$500/month.a.You rent your office space.Explicit costs increas
8、e$500/month.Accounting profit&economic profit each fall$500/month.b.You own your office space.Explicit costs do not change,so accounting profit does not change.Implicit costs increase$500/month(opp.cost of using your space instead of renting it),so economic profit falls by$500/month.8THE COSTS OF PR
9、ODUCTION9The Production FunctionA production function shows the relationship between the quantity of inputs used to produce a good and the quantity of output of that good.It can be represented by a table,equation,or graph.Example 1:Farmer Jack grows wheat.He has 5 acres of land.He can hire as many w
10、orkers as he wants.THE COSTS OF PRODUCTION1005001,0001,5002,0002,5003,000012345No.of workers Quantity of outputExample 1:Farmer Jacks Production Function300052800424003180021000100Q(bushels of wheat)L(no.of workers)THE COSTS OF PRODUCTION11Marginal ProductIf Jack hires one more worker,his output ris
11、es by the marginal product of labor.The marginal product of any input is the increase in output arising from an additional unit of that input,holding all other inputs constant.Notation:(delta)=“change in”Examples:Q=change in output,L=change in labor Marginal product of labor(MPL)=QLTHE COSTS OF PROD
12、UCTION12300052800424003180021000100Q (bushels of wheat)L(no.of workers)EXAMPLE 1:Total&Marginal Product2004006008001000MPLQ=1000L=1Q=800L=1Q=600L=1Q=400L=1Q=200L=1THE COSTS OF PRODUCTION13MPL equals the slope of the production function.Notice that MPL diminishes as L increases.This explains why the
13、production function gets flatter as L increases.05001,0001,5002,0002,5003,000012345No.of workers Quantity of outputEXAMPLE 1:MPL=Slope of Prod Function3000520028004400240036001800280010001100000MPLQ(bushels of wheat)L(no.of workers)THE COSTS OF PRODUCTION14Why MPL Is ImportantRecall one of the Ten P
14、rinciples:Rational people think at the margin.When Farmer Jack hires an extra worker,his costs rise by the wage he pays the workerhis output rises by MPLComparing them helps Jack decide whether he would benefit from hiring the worker.THE COSTS OF PRODUCTION15Why MPL DiminishesFarmer Jacks output ris
15、es by a smaller and smaller amount for each additional worker.Why?As Jack adds workers,the average worker has less land to work with and will be less productive.In general,MPL diminishes as L rises whether the fixed input is land or capital(equipment,machines,etc.).Diminishing marginal product:the m
16、arginal product of an input declines as the quantity of the input increases(other things equal)THE COSTS OF PRODUCTION16EXAMPLE 1:Farmer Jacks CostsFarmer Jack must pay$1000 per month for the land,regardless of how much wheat he grows.The market wage for a farm worker is$2000 per month.So Farmer Jac
17、ks costs are related to how much wheat he produces.THE COSTS OF PRODUCTION17EXAMPLE 1:Farmer Jacks Costs$11,000$9,000$7,000$5,000$3,000$1,000Total Cost3000528004240031800210001$10,000$8,000$6,000$4,000$2,000$0$1,000$1,000$1,000$1,000$1,000$1,00000Cost of laborCost of landQ(bushels of wheat)L(no.of w
18、orkers)THE COSTS OF PRODUCTION18EXAMPLE 1:Farmer Jacks Total Cost CurveQ(bushels of wheat)Total Cost0$1,0001000$3,0001800$5,0002400$7,0002800$9,0003000$11,000THE COSTS OF PRODUCTION19Marginal CostMarginal Cost(MC)is the increase in Total Cost from producing one more unit:TCQMC=THE COSTS OF PRODUCTIO
19、N20EXAMPLE 1:Total and Marginal Cost$10.00$5.00$3.33$2.50$2.00Marginal Cost(MC)$11,000$9,000$7,000$5,000$3,000$1,000Total Cost300028002400180010000Q(bushels of wheat)Q=1000TC=$2000Q=800TC=$2000Q=600TC=$2000Q=400TC=$2000Q=200TC=$2000THE COSTS OF PRODUCTION21MC usually rises as Q rises,as in this exam
20、ple.EXAMPLE 1:The Marginal Cost Curve$11,000$9,000$7,000$5,000$3,000$1,000TC$10.00$5.00$3.33$2.50$2.00MC300028002400180010000Q(bushels of wheat)THE COSTS OF PRODUCTION22Why MC Is ImportantFarmer Jack is rational and wants to maximize his profit.To increase profit,should he produce more or less wheat
21、?To find the answer,Farmer Jack needs to“think at the margin.”If the cost of additional wheat(MC)is less than the revenue he would get from selling it,then Jacks profits rise if he produces more.THE COSTS OF PRODUCTION23Fixed and Variable CostsFixed costs(FC)do not vary with the quantity of output p
22、roduced.For Farmer Jack,FC=$1000 for his landOther examples:cost of equipment,loan payments,rentVariable costs(VC)vary with the quantity produced.For Farmer Jack,VC=wages he pays workersOther example:cost of materialsTotal cost(TC)=FC +VCTHE COSTS OF PRODUCTION24EXAMPLE 2Our second example is more g
23、eneral,applies to any type of firm producing any good with any types of inputs.THE COSTS OF PRODUCTION25EXAMPLE 2:Costs7654321620480380310260220170$10052038028021016012070$0100100100100100100100$1000TCVCFCQ$0$100$200$300$400$500$600$700$80001234567QCostsFCVCTCTHE COSTS OF PRODUCTION26Recall,Marginal
24、 Cost(MC)is the change in total cost from producing one more unit:Usually,MC rises as Q rises,due to diminishing marginal product.Sometimes(as here),MC falls before rising.(In other examples,MC may be constant.)EXAMPLE 2:Marginal Cost6207480638053104260322021701$1000MCTCQ14010070504050$70TCQMC=THE C
25、OSTS OF PRODUCTION27EXAMPLE 2:Average Fixed Cost100710061005100410031002100114.2916.67202533.3350$100n/a$1000AFCFCQAverage fixed cost(AFC)is fixed cost divided by the quantity of output:AFC=FC/QNotice that AFC falls as Q rises:The firm is spreading its fixed costs over a larger and larger number of
26、units.THE COSTS OF PRODUCTION28EXAMPLE 2:Average Variable Cost52073806280521041603120270174.2963.3356.0052.5053.3360$70n/a$00AVCVCQAverage variable cost(AVC)is variable cost divided by the quantity of output:AVC=VC/QAs Q rises,AVC may fall initially.In most cases,AVC will eventually rise as output r
27、ises.THE COSTS OF PRODUCTION29EXAMPLE 2:Average Total Cost88.57807677.5086.67110$170n/aATC6207480638053104260322021701$100074.2914.2963.3316.6756.002052.502553.3333.336050$70$100n/an/aAVCAFCTCQAverage total cost(ATC)equals total cost divided by the quantity of output:ATC=TC/QAlso,ATC=AFC+AVCTHE COST
28、S OF PRODUCTION30Usually,as in this example,the ATC curve is U-shaped.$0$25$50$75$100$125$150$175$20001234567QCostsEXAMPLE 2:Average Total Cost88.57807677.5086.67110$170n/aATC6207480638053104260322021701$1000TCQTHE COSTS OF PRODUCTION31EXAMPLE 2:The Various Cost Curves TogetherAFCAVCATCMC$0$25$50$75
29、$100$125$150$175$20001234567QCosts32Fill in the blank spaces of this table.2101501003010VC43.33358.33260630537.5012.50150436.672016.673802$60.00$101n/an/an/a$500MCATCAVCAFCTCQ6030$1033Use AFC=FC/QUse AVC=VC/QUse relationship between MC and TCUse ATC=TC/QFirst,deduce FC=$50 and use FC+VC=TC.210150100
30、603010$0VC43.33358.33260640.003010.00200537.502512.50150436.672016.67110340.001525.00802$60.00$10$50.00601n/an/an/a$500MCATCAVCAFCTCQ6050403020$10THE COSTS OF PRODUCTION34$0$25$50$75$100$125$150$175$20001234567QCostsEXAMPLE 2:Why ATC Is Usually U-ShapedAs Q rises:Initially,falling AFC pulls ATC down
31、.Eventually,rising AVC pulls ATC up.Efficient scale:The quantity that minimizes ATC.THE COSTS OF PRODUCTION35EXAMPLE 2:ATC and MCATCMC$0$25$50$75$100$125$150$175$20001234567QCostsWhen MC ATC,ATC is rising.The MC curve crosses the ATC curve at the ATC curves minimum.THE COSTS OF PRODUCTION36Costs in
32、the Short Run&Long RunShort run:Some inputs are fixed(e.g.,factories,land).The costs of these inputs are FC.Long run:All inputs are variable(e.g.,firms can build more factories,or sell existing ones).In the long run,ATC at any Q is cost per unit using the most efficient mix of inputs for that Q(e.g.
33、,the factory size with the lowest ATC).THE COSTS OF PRODUCTION37EXAMPLE 3:LRATC with 3 factory SizesATCSATCMATCLQAvgTotalCost Firm can choose from 3 factory sizes:S,M,L.Each size has its own SRATC curve.The firm can change to a different factory size in the long run,but not in the short run.THE COST
34、S OF PRODUCTION38EXAMPLE 3:LRATC with 3 factory SizesATCSATCMATCLQAvgTotalCost QAQBLRATCTo produce less than QA,firm will choose size S in the long run.To produce between QA and QB,firm will choose size M in the long run.To produce more than QB,firm will choose size L in the long run.THE COSTS OF PR
35、ODUCTION39A Typical LRATC CurveQATCIn the real world,factories come in many sizes,each with its own SRATC curve.So a typical LRATC curve looks like this:LRATCTHE COSTS OF PRODUCTION40How ATC Changes as the Scale of Production ChangesEconomies of scale:ATC falls as Q increases.Constant returns to sca
36、le:ATC stays the same as Q increases.Diseconomies of scale:ATC rises as Q increases.LRATCQATCTHE COSTS OF PRODUCTION41How ATC Changes as the Scale of Production ChangesEconomies of scale occur when increasing production allows greater specialization:workers more efficient when focusing on a narrow t
37、ask.More common when Q is low.Diseconomies of scale are due to coordination problems in large organizations.E.g.,management becomes stretched,cant control costs.More common when Q is high.THE COSTS OF PRODUCTION42CONCLUSIONCosts are critically important to many business decisions,including productio
38、n,pricing,and hiring.This chapter has introduced the various cost concepts.The following chapters will show how firms use these concepts to maximize profits in various market structures.Implicit costs do not involve a cash outlay,yet are just as important as explicit costs to firms decisions.Account
39、ing profit is revenue minus explicit costs.Economic profit is revenue minus total(explicit+implicit)costs.The production function shows the relationship between output and inputs.43The marginal product of labor is the increase in output from a one-unit increase in labor,holding other inputs constant
40、.The marginal products of other inputs are defined similarly.Marginal product usually diminishes as the input increases.Thus,as output rises,the production function becomes flatter,and the total cost curve becomes steeper.Variable costs vary with output;fixed costs do not.44Marginal cost is the incr
41、ease in total cost from an extra unit of production.The MC curve is usually upward-sloping.Average variable cost is variable cost divided by output.Average fixed cost is fixed cost divided by output.AFC always falls as output increases.Average total cost(sometimes called“cost per unit”)is total cost
42、 divided by the quantity of output.The ATC curve is usually U-shaped.45The MC curve intersects the ATC curve at minimum average total cost.When MC ATC,ATC rises as Q rises.In the long run,all costs are variable.Economies of scale:ATC falls as Q rises.Diseconomies of scale:ATC rises as Q rises.Consta
43、nt returns to scale:ATC remains constant as Q rises.46THE COSTS OF PRODUCTION47The Complete Data for Example 2102.509012.50820720100888.5774.2914.2962052010078063.3316.6748038010067656.0020380280100577.5052.5025310210100486.6753.3333.33260160100311060502201201002$170$70$100170701001n/an/an/a$100$0$1
44、000MCATCAVCAFCTCVCFCQ20014010070504050$70THE COSTS OF PRODUCTION48Problems and Applications:Your aunt is thinking about opening a hardware store.She estimates that it would cost$500,000 per year to rent the location and buy the stock.In addition,she would have to quit her$50,000 per year job as an accountant.a.Define opportunity cost.b.What is your aunts opportunity cost of running a hardware store for a year?If your aunt thought she could sell$510,000 worth of merchandise in a year,should she open the store?Explain.48
