PRINCIPLES OF ECONOMICS Chapter 7 Cost and Industry Structure PowerPoint Image Slideshow

FIRM AND PRODUCTION COST Amazon is an American international electronic commerce company that sells books, among many other things, shipping them directly to the consumer.

MARKET STRUCTURE Perfect Competition: Many small firms selling “identical” products Monopolistic Competition: Many small-medium firms selling “similar” products Oligopoly: A few big firms selling “differentiated” products Monopoly: Only one firm selling “unique” products

MARKET STRUCTURE

BUSINESS CONCEPTS Cost: expenses of hiring resources for production of goods and services Revenue: incomes made from sale of goods and services Profit = Revenue - Cost

ECONOMIC VS. ACCOUNTING COST Accounting Cost: Out-of-pocket costs or payments to suppliers of resources (e.g., wage, interest, rent) Economic Cost: Out-of-pocket cost + Opportunity cost Opportunity Cost: Cost of using own resources (e.g., managing your own business; using own vehicle for business)

PRODUCTION & COST FUNCTIONS Production Function: A graph showing the quantity of inputs used in production of various quantities of output Cost Function: A graph showing expenses of producing various quantities of output

PRODUCTION COSTS Fixed Costs: Costs of hiring fixed inputs (e.g., rent, insurance premiums) Variable Costs: Costs of hiring variable inputs (e.g., wages, material costs)

TOTAL COST FUNCTION At zero production, the fixed costs = $160. As production increases, variable costs are added to fixed costs. TC = TFC + TVC

SHORT-RUN COST FUNCTIONS Marginal Cost: Additional cost of producing an extra unit of output = Δ Total Cost / Δ Output Average Total Cost = Total Cost / Output Total cost per unit of output Average Variable Cost = Total Variable Cost / Output Variable cost per unit of output Average Fixed Cost = Total Fixed Cost / Output Fixed cost per unit of output

SHORT-RUN COST FUNCTIONS OutputTVCTFCTCMC*ATCAVCAFC * MC is per 100 units of output

SHORT-RUN COST FUNCTIONS

ECONOMIES OF SCALE Economies of scale: In the long-run, Average Cost falls as output expands due to internal efficiencies (e.g., buying raw materials in large volumes at discounted prices) A small factory like S produces 1,000 alarm clocks at AC = $12 per clock. A medium factory like M produces 2,000 alarm clocks at AC = $8 per clock. A large factory like L produces 5,000 alarm clocks at AC = $4 per clock. 5-13

ECONOMIES OF SCALE LONG-RUN AC DECLINES AS MORE OUTPUT PRODUCED

LONG-RUN AVERAGE COST The LRAC is the “envelope” of SRAC curves The LRAC curve is actually based on a group of SRAC curves, each of which represents one specific level of fixed costs. More precisely, the LRAC curve will be the least expensive average cost curve for any level of output. 5-15

LONG-RUN AVERAGE COST

Minimum Efficient Scale (MES) Plant size at which the LRAC reaches its minimum point as the firm experiences extended economies of scale MES helps determine the number of firms in an industry and therefore the level of competition 5-17

LONG-RUN AVERAGE COST