LECTURE #11: MICROECONOMICS CHAPTER 13 Revenues Costs Profits

Basics of Economic Accounting A.Operating Costs 1.Direct (Production) Costs: labor, materials 2.Indirect (Non-Production) Costs: administrative, marketing, support services 3. 3.In the long run, all costs are variable. In the short run, firm will have some fixed costs and some costs that vary with output B.Capital Costs 1.The opportunity costs of invested capital a.Explicit costs require an outlay of money b.Implicit costs do not require and outlay of money c.The rate of return from A1 compared to A2.

Basics of Economic Accounting C.Profits 1.The difference between Revenue and Total Costs (operating and non-operating) 2.Accounting Profits: the kind identified by GAAP 3.Economic profits: When cash income exceeds the opportunity cost of capital 4.Contribution Concept: Accepting business at a unit price below normal when excess capacity exists D.Revenues 1.Price times Quantity 2.Operating versus Non-Operating

Production Costs A.Production Function 1.Mix of labor and capital utilized to convert inputs to outputs 2.Capital versus Labor Intensive B.Marginal Product 1.The additional output achieved by the adding of an additional unit of labor 2.Additions should continue until the cost of the last unit of labor added is equal to the revenue generated by the additional output produced. 3.Marginal product assumed to diminish as units of labor are added.

Caroline’s Cookie Factory Number of workers Output (quantity of cookies produced per hour) Marginal product of labor Cost of factory Cost of workers Total cost of inputs (cost of factory + cost of workers) $30 30 $ $

Total Cost $90 Quantity of Output (cookies per hour) Caroline’s Production Function and Total Cost Curve 6 (a) Production function Panel (a) shows the relationship between the number of workers hired and the quantity of output produced. The production function gets flatter as the number of workers increases, which reflects diminishing marginal product. Panel (b) shows the relationship between the quantity of output produced and total cost of production. The total-cost curve gets steeper as the quantity of output increases because of diminishing marginal product.. The size and cost of the factory is assumed fixed. (b) Total-cost curve Number of Workers Hired Production function Total-cost curve Quantity of Output (cookies per hour)

Measures of Cost A.Fixed Costs: costs invariant to level of output B.Variable costs: costs that vary as output varies C.Average Total Costs (ATC) 1.ATC = Total Costs ÷ Units of Output (Q) 2.ATC = Fixed Costs + Average Variable Costs 3.ATC form the basis for [most] pricing decisions D.Marginal Cost (MC) 1.MC =  TC ÷  Q  = change in 2.The increase in Total Costs arising from an additional unit of output

Measures of Cost E.Cost Curves and Shapes 1.Average Fixed Costs (AFC) declines as output increases 2.Average Variable Costs (AVC) rises as output increases 3.Average Total Costs (ATC) tends to be U-shaped 4.Points of Interest a.Intersection of MC and AVC curves b.Intersection of MC and ATC curves

Cost Curves for a Typical Firm 9 Costs $3.00 Pt A defines the optimal scale of plant Pt B defines the shut-down decision point. If P < AVC, the better to shut down. The portion of MC curve between B and A indicates economic losses are incurred (MC < ATC) Quantity of Output MC ATC AVC AFC A B

Short Run Cost Considerations in Perfectly Competitive Markets A.Average Total Costs and Scale of Plant 1.ATC tends to decline as scale of plant increases 2.ATC will start to increase when the scale of plant becomes too large 3.The Optimal Scale of Plant minimizes ATC B.Marginal Cost and Marginal Revenue Curves 1.Profits are maximized whenever MR = MC 2.The Marginal Cost curve is the producer's supply function

Marginal Cost and Marginal Revenue Curves 1. Profits are maximized whenever MR = MC and MC > ATC

Marginal Cost and Marginal Revenue Curves 2. The Marginal Cost curve is the producer's supply function

Long Run Considerations in Perfectly Competitive Markets A.Long Run Equilibrium Conditions 1.Economic Efficiency obtains when P = MC 2.Perfect Competition requires MR = AR = P 3.Breakeven Output defined as P = AR = ATC 4.Production costs minimized when a.MC = ATC (optimal scale of plant) b.LRAC = LRMC

Homework A.Questions for Review: 1, 3, 5 B.Problems and Applications: 1, 3 (#4 in 4th Ed), 4 (#5 in 4th Ed)