Production Costs Chapter 9 4/7/2019
Economic or Opportunity Cost The value or worth the resource would have in its best alternative use. Remember the pizza robots example??? Opportunity cost of producing more pizzas is the robots that are not produced. 4/7/2019
Economic Costs Payments a firm must make to attract the resources it needs away from alternative production opportunities. Two types of economic costs: explicit & implicit These are explicit or implicit payments which will be discussed in the next slide. 4/7/2019
Explicit Costs Cash payments a firm makes to those who supply labor services, materials, fuel, & transportation services. These payments are for the use of resources owned by others. 4/7/2019
Implicit Costs Opportunity cost of self-owned, self-employed resources. These costs are the payments that self-employed resources could have earned in their best alternative use. 4/7/2019
Accounting & Economic Profit Accounting (Normal)- Cost of doing business. Total revenue – explicit (accounting) costs Economic Profit = total revenue – economic costs Economic costs are explicit and implicit. Do example on page 158. 4/7/2019
Total accounting profit = 57,000 Total sales revenue: $120,000 Cost of t-shirts: $40,000 Clerk’s salary: $18,000 Utilities: $5,000 Total explicit costs = 63,000 Total accounting profit = 57,000 4/7/2019
Forgone entrepreneurial income: 5,000 Implicit costs (total) = 33,000 Accounting profit = $57,000 Forgone interest: 1,000 Forgone rent: 5,000 Forgone wages: 22,000 Forgone entrepreneurial income: 5,000 Implicit costs (total) = 33,000 Economic profit = 24,000 4/7/2019
Short Run Period too brief for a firm to alter its plant capacity Period long enough to permit a change in the degree to which the fixed plant is used. The firm can vary its output by applying different amounts of resources to the plant. 4/7/2019
Long Run Period long enough to adjust the quantities of all the resources it employs, including plant capacity. In the long run, existing firms can dissolve and leave the industry…new firms can enter as well. 4/7/2019
Short-Run Production Relationships Total Product (TP)- total quantity (output) of a particular good produced. Marginal Product (MP)- extra output or added product associated with adding a unit of a variable resource to the production process. Average Product (AP)- output per unit of labor (TP/labor) Read first: a firm’s costs of producing something depends on the prices of the resources needed and how much is needed to produce the product. 4/7/2019
Law of Diminishing Returns As more units of a variable resource (I.e. labor) are added to a fixed resource (I.e. land)… The marginal product attributed to each additional unit of the variable resource will decline. Do table 9.1 on board page 161…also do key graph on page 162 4/7/2019
Average Product (TP/Labor) Key Graph Resource Units Total Product Marginal Product Average Product (TP/Labor) --- 1 10 2 25 3 45 4 60 5 70 6 75 7 8 4/7/2019
Short-Run Production Costs Fixed costs- those costs that do not vary with changes in output (I.e. rent). Variable costs- those costs that change with the level of output (I.e. materials & labor). Total costs- sum of fixed & variable at each level of output. 4/7/2019
Per-Unit or Average Costs Average fixed costs (afc)- total fixed cost/output. Average variable costs (avc)- total variable/output. Average total costs (atc)- afc + avc 4/7/2019
Marginal cost (mc) Extra or additional cost of producing one more unit of output. Complete table 9.2 on page 163 and key graph figure 9.5 on page 166 4/7/2019
Key Graph TFC TVC TC MC AFC AVC ATC 100 --- 1 90 2 170 3 240 4 300 5 Total Product TFC TVC TC TFC+TVC MC ΔTC AFC TFC/TP AVC TVC/TP ATC AFC+AVC or TC/TP 100 --- 1 90 2 170 3 240 4 300 5 370 6 450 7 540 8 650 9 780 10 930 4/7/2019
Graphs MC curve declines sharply at first, reaches a minimum, and then rises quickly. Why??? Variable & total costs increase rather dramatically as more of a product is produced. 4/7/2019
Relation of MC to AVC & ATC MC intersects both the AVC & ATC at their minimum point. 2) Baseball ERA analogy. 4/7/2019
Long-Run Cost Curve Vertical lines perpendicular to the atc curves lowest point create a portion of the long run average total cost curve. This long-run curve is made up of segments of short-run atc curves. 4/7/2019
Economies of Scale Reductions in the average total cost of producing a product as the firm expands the size of plant in the long run (mass production). 4/7/2019
Diseconomies of Scale Increases in the average total cost of producing a product as the firm expands in size of its plant in the long run. 4/7/2019
Minimum Efficient Scale (MES) Lowest level of output at which a firm can minimize long-run average costs. 4/7/2019
Natural monopoly Average total cost is minimized when one firm produces the good or service This does not happen often 4/7/2019