Chapter 8 Production and Costs

Marginal Physical Product (MPP) What is the variable input? What is the variable cost?

So… As more labor (VARIABLE INPUT) are added to land (FIXED INPUT) the variable inputs would yield smaller and smaller additions to output

Marginal Physical Product

Crowding Problem The point at which MPP declines Shows the law of diminishing returns

Average Physical Productivity Output divided by Inputs (usually labor) Good for comparing firms or countries.

So find that… MC and MPP are related What is the relationship?

In –class exercise 10 Does MPP show Diminishing Returns???

Law of Diminishing Marginal Returns

Marginal Cost

Does this relationship make sense? Yes.. If productivity increases what would happen to costs?? Decrease (MPP increase & MC decrease) Productivity decreases?? Increase (MPP decreases & MC increases)

MPP determines shape of MC MPP must have a declining part because of diminishing returns Can also define MC as:

How do we calculate these costs?? Give two ways to get to the cost… In-class exercise 11 How do we calculate these costs?? Give two ways to get to the cost…

Average-Marginal Rule Can use to see what the ATC and AVC curve look like Tells us what happens when MC is above or below the “average” curves If MC is above AVC and ATC AVC and ATC are rising If MC is below AVC and ATC AVC and ATC are falling

From Average-Marginal Rule can infer… MC intersects the AVC and ATC curves at their MINIMUM POINTS Cannot infer anything about AFC

Average and Marginal Cost Curves

Average and Marginal Cost Curves

So… MC gains it shape from??? MC below ATC: What is ATC curve doing? MPP and law of diminishing marginal returns MC below ATC: What is ATC curve doing? Falling MC above ATC: What is ATC curve doing? Rising

Average and Marginal Cost Curves

Tying Products to Costs A CLOSER LOOK MPP Variable Input When MC is below ATC, AVC MC Production in the short run: at least one fixed input When MC is above ATC, AVC MPP Variable Input MC

Now switching to the Long Run When does Long Run start? As soon as all inputs (costs) are VARIABLE No fixed costs Important curves LRTC LRATC LRMC

Short Run vs. Long Run Short Run assumes FIXED plant size Each plant size has a unique ATC curve associated with it SRATC LRATC combines all the SRATC curves Which points of the SRATC??? Minimum points

Why minimum? LRATC shows the lowest average cost at which a firm can produce any given level of output LRATC is the lower ENVELOPE of the SRATC curves Called envelope curve

Long-Run Average Total Cost Curve (LRATC)

Isn’t the LRATC curve smooth?? Yes!! Have infinitely many SRATC curves so it would be smooth if use all curves Each SRATC curve touches the LRATC curve only once

Shape of LRATC U-shaped Decreasing, Flat, then Increasing Important when finding optimal long run output level

Long-Run Average Total Cost Curve (LRATC)

Economies of Scale Downward part of LRATC Average costs decrease as output increases If have a 1% increase in input usage what happens to output?? Increases by MORE than 1% Specialization

Constant Returns to Scale Flat portion of LRATC Costs remain the same as increase output If have a 1% increase in input usage what happens to output?? Output increases by EXACTLY 1% First point of constant returns to scale is called MINIMUM EFFICIENT SCALE

Diseconomies of Scale Upward sloped portion of LRATC Costs are rising as we increase output If have a 1% increase in input usage what happens to output? Increases by LESS THAN 1% Why??? Firm too large (bad communication or coordination problems)

Long-Run Average Total Cost Curve (LRATC)

Are economies, diseconomies, and constant returns to scale in SR, LR, or both??? LONG RUN ONLY!!! Why? Inputs necessary for production are able to be changed No fixed inputs

Is this the same as diminishing returns? NO Diminishing returns is from using ONE plant size intensely Short run Economies of scale is from CHANGING plant size Long run

Review Economies of Scale Constant Returns to Scale LRATC falling Constant Returns to Scale LRATC flat Diseconomies of Scale LRATC rising

Why does economies of scale exist? Large firms offer more opportunity for workers to specialize Growing firms can take advantage of efficient mass production techniques Smooth cost over more units produced

Why does diseconomies of scale exist? Communication problems Shirking Management problems

Why is minimum efficient scale important? Lowest output level at which ATC are minimized Which has a cost advantage?? Small firm at minimum efficient scale point Larger firm producing more output but still within constant returns to scale area Neither

Long-Run Average Total Cost Curve (LRATC)

Minimum Efficient Scale for Six Industries

Where would you expect to find less firms? (using MES) Firms with higher MES Why?? Produce until MES If MES is higher then each firm will be producing more…so need less firms to cover quantity wanted by economy Many SHOE companies (MES = .2) Few REFRIGERATOR companies (MES = 14)

Efficient Number of Firms 100 divided by MES 100% of goods are wanted by consumers MES is the percentage of consumption each firm will provide Cigarette firm’s MES = 6.6 Need 15 firms Petroleum firm’s MES = 1.9 Need 52 firms Thus a larger MES means less firms needed

What cause SRTC, LRTC, and MC to shift? Taxes Does it affect FC?? Only if it is a lump sum tax (tax for existing) If it is a per unit tax then FC doesn’t change How does it change curves?? Input prices Technology Either improves production process (use less inputs) or lower input prices

Homework Chapter 8 Working with numbers and graphs Questions: 3, 5, 10, and 11 Working with numbers and graphs Questions 3, 6, and 7

Do we understand Chapter 8?? In-class exercise 12 Do we understand Chapter 8??