1 Chapter 8 Costs of Production Costs of Production Principles of Economics by Fred M Gottheil PowerPoint Slides prepared by Ken Long © ©1999 South-Western.

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Presentation transcript:

1 Chapter 8 Costs of Production Costs of Production Principles of Economics by Fred M Gottheil PowerPoint Slides prepared by Ken Long © ©1999 South-Western College Publishing

2 What is a Production Function? A relationship between inputs and outputs

3 Q = f(L, C) Q = output L = labor input C = capital input

4 What is the Short Run? A time in which producers can change some, but not all of its resources (inputs) © ©1999 South-Western College Publishing

5 What is the Long Run? The time period in which producers can change any of its resources © ©1999 South-Western College Publishing

6 Example of a production function TP = total product or output, MP = marginal product

7 Total and marginal product curves Total Product Labor Marginal Product Labor

8 Marginal Product Labor I II III Zone 1, increasing MP Zone 3, negative MP Zone 2, diminishing MP Can you see why the firm is likely to end up operating in zone 2?

9 What is the Law of Diminishing Returns? As more units of a resource are added to production output will increase by smaller amounts, ceteris paribus © ©1999 South-Western College Publishing

10 Short Run Costs of Production Total costs = Total Fixed costs + Total Variable costs TC = TFC + TVC

11 What is a Fixed Cost? Cost to a firm that does not vary with the quantity of goods produced © ©1999 South-Western College Publishing

12 What are examples of Fixed Costs? rent or mortgage loan payments certain salaries a part of utilities property taxes © ©1999 South-Western College Publishing

13 What are some other names for Fixed Cost? Sunk and Historical © ©1999 South-Western College Publishing

14 What is a Variable Cost? Cost that varies with the quantity of goods produced © ©1999 South-Western College Publishing

15 What are examples of Variable Costs? worker’s wages raw materials some utilities some taxes © ©1999 South-Western College Publishing

16 What is Total Variable Cost? The sum of specific variable costs in the firm’s cost structure © ©1999 South-Western College Publishing

17 Total Fixed cost curve Q TFC 0

18 Total Variable Cost Curve Q TVC 0

19 Total Costs, Sum of Variable and Fixed Cost Q TC 0 TVC TFC TC

20 What is Average Total Cost? Total cost divided by the quantity of goods produced ATC = TC/Q

21 What is Average Fixed Cost? Total fixed cost divided by the quantity of goods produced AFC = TFC/Q

22 What is Average Variable Cost? Total variable cost divided by the quantity of goods produced AVC = TVC/Q

23 ATC AVC Ave. Fixed Costs 23 Q $

24 What is Marginal Cost? The change in total cost generated by a change in the quantity of a good produced © ©1999 South-Western College Publishing

25 MC = Q TC = TVC Q

26 Why does MC = ATC at minimum ATC? If the margin is above the average, the average increases If the margin is below the average, the average decrease © ©1999 South-Western College Publishing

27 $ Q ATC AVC MC Ave. Fixed Costs 27

28 What are Economies of Scale? When a firm increases resources in the long run and efficiency increases © ©1999 South-Western College Publishing

29 What can cause economies of scale? Increased specialization Specialized capital equipment Dimensional factors

30 What are Diseconomies of Scale? When a company increases resources in the long run and efficiency decreases © ©1999 South-Western College Publishing

31 What can cause diseconomies of scale? Limits to efficient functioning of management Layers of bureacracy

32 Costs in the Long Run and Economies of Scale Output Cost per unit AC Economies of scale Diseconomies of scale 32

33 The Family of Short-Run Average Cost Curves Output per period $ Long-run average cost ATC 1 ATC 2 ATC 3 33

34 What are different views concerning downsizing? © ©1999 South-Western College Publishing

35 What is Labor Productivity? The output per laborer per hour © ©1999 South-Western College Publishing

36 Which is cheaper to pay $10 an hr. to a U.S. worker or $1 an hour to a foreign worker? © ©1999 South-Western College Publishing

37 © ©1999 South-Western College Publishing The $10 an hour may be cheaper if the U.S. worker is a lot more productive than the foreign worker

38 What is a Fixed Cost? What is a Variable Cost? What are Total Costs? What is Marginal Cost? What is the Short Run? What is the Long Run? What are Economies of Scale? What are Diseconomies of Scale?

39 ENDEND © ©1999 South-Western College Publishing