The Theory of the Firm Economic costs (Explicit, Implicit) Fixed, variable costs Total, average, marginal costs

Average Costs (AFC/AVC/ATC) Marginal Cost (MC) TYPES OF COSTS There are three main types of costs: Total Costs (TFC/TVC/TC) Average Costs (AFC/AVC/ATC) Marginal Cost (MC)

Total, Average and Marginal Costs Per Week Case Study: Cost of a machine per week $100 (4 machines) Cost of a worker is $200 per week. Outcome is below:

Read Tragakes p. 144-146 & answer these Qs Define: costs of production, explicit costs, implicit costs, economic costs, fixed costs, variable costs, total costs, marginal costs, average costs Also… Know short run v. long run w/fixed & variable Give examples of fixed & variable costs Write down equations

The Relationship between ATC, AVC, and MC Curves The MC curve cuts the AVC & the ATC curves at their lowest points. Why does gap between ATC and AVC get smaller? B/c AFC falls as output increases

Make sure when you draw the MC, that it intersects the ATC and the AVC at their lowest points!

Let’s work on the “costs – Short term” practice activity PRACTICE Time! Let’s work on the “costs – Short term” practice activity

https://www.youtube.com/watch?v=qYKJdooEnwU - 3.5 MINS Mr. Clifford on “Cost Curves” https://www.youtube.com/watch?v=qYKJdooEnwU - 3.5 MINS

Production & costs in the long run And now… Production & costs in the long run

How many fixed inputs exist in the long run?

Example of decreasing returns to scale: THE LONG RUN Looks at when all factors of inputs are increased Decreasing returns to scale Example of decreasing returns to scale: Increasing inputs by 25%, would increase the actual output by less than 25% (e.g. 20%)

BUT… BOTH LOOK AT PRODUCTION: OUTPUTS V. INPUTS (NOT COSTS!) Do NOT confuse! DIMINISHING MAGINAL RETURNS Occur only in short run Shows what happens to output as a variable input is added to a fixed input Firms must plan for future, otherwise will face diminishing returns DECREASING RETURNS TO SCALE Occur only in long run Shows what happens to output when all inputs are variable BUT… BOTH LOOK AT PRODUCTION: OUTPUTS V. INPUTS (NOT COSTS!)

Analysis Movement from Q1 to Q2 (Good idea?) The Long Run Average Cost Curve (LRAC) In theory the long-run average cost curve (LRAC) is an “envelope” curve”. It envelops an infinite number of short run-average cost curves (SRAC). Analysis Movement from Q1 to Q2 (Good idea?) Where best to produce @ Q2? Movement from SRATC1 to SRAC2 (Good idea?) Can points be same on SRATC as LRATC? In theory, are there unlimited SRATCs? FYI: Cannot produce cheaper than LRATC (unattainable)

How much does the law of diminishing returns affect the shape of the LRATC curve?

REMINDER Where on the graph is this true? a % increase in all factors of production will lead to smaller % increase in output, increasing long run average costs

What Are…? ECONOMIES OF SCALE DISECONOMIES OF SCALE Decreases in avg costs of production over long run as a firm increases all its inputs FYI: Related but different increasing returns to scale – focuses on production diseconomies of scale – focuses on costs DISECONOMIES OF SCALE Increases in avg costs of production over long run as a firm increases all its inputs FYI: Related but different decreasing returns to scale – focuses on production diseconomies of scale – focuses on costs

What Causes…? ECONOMIES OF SCALE DISECONOMIES OF SCALE Specialisation Of labour Of management Efficiency Of capital equipment Marketing Indivisibilities Of efficient processes DISECONOMIES OF SCALE Coordination and monitoring difficulties Communication difficulties (Extra: Poor worker motivation)

Quiz yourself… What is the difference between (1) diminishing marginal returns (2) diseconomies of scale, and (3) decreasing returns to scale? What is the difference between (1) diminishing marginal returns Short run production (2) diseconomies of scale Long run avg costs OUTPUT V. COSTS (AS INPUTS INCREASE) (3) decreasing returns to scale? Long run avg production INPUT V. OUTPUT

(1) START STUDYING FOR TEST & (2) STUDY REVENUE For next class… (1) START STUDYING FOR TEST & (2) STUDY REVENUE