1. FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY5
FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

2. The Costs of Production13
The Costs of Production

3. The Firm’s Objective … is to MAXIMIZE PROFIT Profit = TR - TC
Total Revenue = The amount a firm receives for the sale of its output (P x Q)
Total Cost = market value of inputs firm uses in production
Profit = TR - TC
Maximum Profits

4. Costs as Opportunity Costs
Cost of producing an item must include all opportunity costs of inputs used
Includes explicit costs and implicit costs
Explicit costs = input costs that require a direct outlay of money by the firm.
Implicit costs = input costs that do not require an outlay of money by the firm
When TR exceeds both explicit and implicit costs, the firm earns economic profit
Economic profit is smaller than accounting profit.
Quick Quiz 1

5. Figure 1 Economic versus Accountants
How an Economist
How an Accountant
Views a Firm
Views a Firm
Revenue
Economic
profit
Accounting
profit
Revenue
Implicit
costs
Total
opportunity
costs
Explicit
costs
Explicit
costs
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6. Quick Quiz #1
Farmer McDonald gives banjo lessons for $20 an hour. One day, he spends 10 hours planting $100 worth of seeds on his farm. What opportunity cost has he incurred? What cost would his accountant measure? If these seeds yield $200 worth of crops, does McDonald earn an accounting profit? Does he earn an economic profit?

7. Table 1 A Production Function and Total Cost: Hungry Helen’s Cookie Factory
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8. PRODUCTION AND COSTS
The Production Function shows the relationship between quantity of inputs used to make a good and the quantity of output of that good

9. Quick Quiz #2
Plot Helen’s production function; place the level of labor on the x-axis against the level of output on the y-axis.
What happens to the marginal change in output as Helen hires more workers?

10. The Production Function
Marginal Product = increase in output that arises from an additional unit of input
Marginal Product of Labor = slope of the production function (change in output / change in labor)
Property of Diminishing Marginal Product = marginal product of an input declines as the quantity of the input increases
Short-run phenomenon!
Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment.

11. The Production Function
Diminishing Marginal Product
The slope of the production function measures the marginal product of an input, such as a worker.
When the marginal product declines, the production function becomes flatter.

12. I need two volunteers to start the game…
RICE GAME
I need two volunteers to start the game…

13. Answer the following in your notes:
Refresher #1
Answer the following in your notes:
Draw the production function curve using the data from our simulation. What does the slope of this curve indicate? (Put output on the y-axis and labor on the x-axis).
How did this simulation demonstrate the law of diminishing marginal product?
How would the results of this simulation differ if we were looking at the long-run scenario?

14. Economics, Yada, Yada, Yada…
Happy Thursday. Any Seinfeld fans in here???

15. Lots of Graphing Today…
Production Function Curve
(We did this on yesterday)
Total Cost Curve
Marginal Cost Curve
Average Total Cost Curve
Average Fixed Cost Curve
Average Variable Cost Curve
(We are doing these today)

16. Total-Cost Curve
Relationship between quantity firm can produce and its costs determines pricing decisions
Total-cost curve shows this relationship graphically.

18. Quick Quiz #1
If Farmer Jones plants no seeds on his farm, he gets no harvest. If he plants 1 bag of seeds, he gets 3 bushels of wheat. If he plants 2 bags, he gets 5 bushels. If he plants 3 bags, he gets 6 bushels. A bag of seeds costs $100, and seeds are his only cost. Use these data to graph the farmer’s production function and total-cost curve. Explain their shapes.

19. VARIOUS MEASURES OF COST
Costs of production may be divided into:
Fixed costs: do not vary with the quantity of output produced
Variable costs: do vary with the quantity of output produced
TC = TFC + TVC

20. Krzyzanowski quits her teaching job…

21. … and opens a coffee shop!

22. Decisions, Decisions…
How should I price my coffee? How much should I make?
Things to consider:
How much does it cost to make the typical cup of coffee?
How much does it cost to increase production of coffee by 1 cup?

23. Represents cost of each typical unit produced
Average Costs
Represents cost of each typical unit produced

24. Marginal Cost
Tells us how much it costs to produce an additional unit of output

25. Why it’s important to understand both ATC & MC…
ATC tells us cost of the typical unit, but doesn’t tell us how much total cost will change as a firm alters its level of production – MC does!
Business managers need to keep both in mind when deciding how much of their product to supply to the market!

26. Plot the following curves on your graph: ATC, AFC, AVC, and MC
Hypothesize:
Why is each curve shaped the way it is? Come up with a hypothesis for each.
What is the relationship between ATC and MC?

27. Cost Curves & Their Shapes
MC < ATC  ATC decreases
MC > ATC  ATC rises

28. Quick Quiz 2: Relationship Between MC & ATC
Two twins are enrolled in AP Microeconomics. They each had a “B” average (GPA = 3.0) before taking the class.
Twin One gets a “C” in the course. What happens to her GPA?
Twin Two gets an “A” in the course. What happens to her GPA?
What can you imply about a “marginal” grade lower than the average?
What can you imply about a “marginal” grade higher than the average?

29. Cost Curves & Their Shapes
Marginal cost rises with the amount of output produced.
Positive slope reflects the property of diminishing marginal product.

30. Cost Curves & Their Shapes
Average Fixed Cost always declines as output rises b/c FC is spread over larger # of units (reflected in negative slope)

31. Cost Curves & Their Shapes
Average Variable Cost typically rises as output increases b/c of diminishing marginal product (Think about what happened during our game on Thursday as we added more workers! Variable costs increased but productivity declined!)

32. Cost Curves and Their Shapes
ATC curve is U-shaped and reflects both AFC & AVC.
At very low levels of output ATC is high because fixed cost is spread over only a few units.
ATC declines as output increases.
Eventually, ATC starts rising because average variable cost rises substantially.

33. Cost Curves and Their Shapes
Bottom of the U-shaped ATC curve occurs at quantity that minimizes average total cost
Called the efficient scale of the firm
The marginal-cost curve crosses the average-total-cost curve at the efficient scale

34. COSTS IN THE SHORT RUN AND IN THE LONG RUN
For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.
In the short run, some costs are fixed.
In the long run, fixed costs become variable costs.

35. COSTS IN THE SHORT RUN AND IN THE LONG RUN
Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.

36. Figure 7 Average Total Cost in the Short and Long Run
ATC
in short
run with
small factory
ATC
in short
run with
medium factory
ATC
in short
run with
large factory
Cost
$12,000
ATC
in long run
1,200
Quantity of
Cars per Day
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37. Economies and Diseconomies of Scale
Economies of scale refer to the property whereby long-run average total cost falls as the quantity of output increases.
Diseconomies of scale refer to the property whereby long-run average total cost rises as the quantity of output increases.
Constant returns to scale refers to the property whereby long-run average total cost stays the same as the quantity of output increases

38. Figure 7 Average Total Cost in the Short and Long Run
ATC
in short
run with
small factory
ATC
in short
run with
medium factory
ATC
in short
run with
large factory
Cost
ATC
in long run
Economies of
scale
Diseconomies of
scale
1,200
$12,000
1,000
10,000
Constant
returns to
scale
Quantity of
Cars per Day
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