1. CHAPTER 13
Costs
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2. Output and Productivity
Costs
Costs of resource services needed to produce output
The more productive the resources
The fewer that are required to produce any given amount of output
Productivity
Output per unit of a resource’s services
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3. Output and Productivity
Labor productivity
Quantity of output divided by the number of hours worked by labor
Everything else held constant
Land productivity
Quantity of output divided by the quantity of land
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4. Output and Productivity
Capital productivity
Total output divided by total capital
Total factor productivity
Total output divided by total inputs
Productivity
The efficiency with which inputs are converted into output
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5. Figure 13.1 Productivity Growth Has a Big Impact on Living Standards
Productivity growth and economic growth are positively correlated. When productivity rises, so do living standards.
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6. Output and Productivity
Increases in productivity
From improvements in the quality of resources
Technological change – enables resources to be more efficient
Human capital
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7. From Production to Costs
When productivity is rising
Costs are declining
The same amount of output can be produced using fewer resources
When productivity is falling
Costs are rising
The same amount of output requires more resources
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8. From Production to Costs
Total factor productivity
Measure of the change in output resulting from a change in all resources
Marginal productivity
Change in output that results from a change in just one resource
Everything else held constant
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9. From Production to Costs
Law of diminishing marginal returns
As a variable resource is increased and combined with a fixed quantity of other resources
Marginal productivity will initially rise but eventually will decline
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10. Table 13.1 Production and Diminishing Marginal Returns
The combinations of total output (thousands of daily passenger miles) that can be produced by an airline using different combinations of mechanics and airplanes. If one resource is fixed, such as number of airplanes fixed at 10, then increasing the number of mechanics increases output but by decreasing amounts. This is diminishing marginal returns.
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11. From Production to Costs
Average total cost (ATC)
Cost per unit of output
Total cost divided by quantity of output
Falls initially and then rise as output rises
Law of diminishing marginal returns
Marginal cost (MC)
Change in total cost divided by the change in the quantity of output
Additional cost that comes from producing an additional unit of output
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12. From Production to Costs
Marginal product of labor (MP)
Additional quantity that comes from an additional unit of labor services
Marginal cost of output, MC = W/MP
W – the wage rate
Additional cost of labor
MP – marginal product of labor
Falls initially and then rises as output rises
Law of diminishing marginal returns
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13. From Production to Costs
MC and MP
When marginal productivity (MP) is rising
Fewer additional resources are used to produce a certain amount of additional output
Marginal cost is falling
When marginal productivity is falling
Marginal cost is rising
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14. Table 13.2 Total, Average, and Marginal costs
a- This is the average of the individual unit marginal cost. The marginal cost of $10 for the first 99 units indicates that the average marginal cost of units 1 through 100 is $101, and so on for units 101–250, units 251–360, etc.
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15. Fixed and Variable Costs
Fixed costs, TFC
Costs that do not change as the quantity of output changes
Variable costs, TVC
Costs that depend on the quantity of output
Total costs, TC = TFC + TVC
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16. Table 13.3
Cost Schedules
This table shows the calculation of the various cost measures. Average costs (average fixed, average variable, average total) are derived by dividing total costs (fixed, variable, total) by output. Marginal cost is the change in total cost divided by the change in output.
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17. Fixed and Variable Costs
Average total cost curve
U-shaped
As output rises, per-unit costs initially fall but eventually rise
Law of diminishing marginal returns
Marginal cost curve
As output rises, incremental costs initially fall but eventually rise
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18. Figure 13.2
Average Total Cost (ATC) and Marginal Cost (MC) are U-shaped Due to The Law of Diminishing Marginal Returns
The figures in Table 13.3 are plotted. MC, AVC, and ATC all fall initially and then rise. AFC continually falls. MC intersects AVC and ATC at their minimum points.
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19. Operating Leverage, Sunk Costs
Ratio of fixed costs to variable costs
If it is high – the firm has less flexibility
Sunk costs
Costs that have already been incurred and that cannot be recovered
Gone and not retrievable
Should not influence decisions
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20. Operating Leverage, Sunk Costs
Sunk cost fallacy, the Concorde Effect
Sunk costs are used to justify continued action
Sunk costs
Often enter into strategic decisions
Developers - get work underway
Build foundations, clear areas
Once money has been spent - difficult for financiers to do anything except scream and holler
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21. Business Insight A Builder’s View of Sunk Costs
Jonathan Ward, a remodeler
Humans seem to be the only animals that don’t understand the concept of sunk costs
Waste time trying to find someone to blame
Or someone to sue
Go on TV talk shows to weep about their misfortune
Attempt to “seek closure”
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22. Business Insight A Builder’s View of Sunk Costs
Jonathan Ward, a remodeler
It is important to know when a situation is untenable
And when to walk away from a project
You must continually ask yourself if, knowing what you know now, you would have funded the venture in the beginning
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23. The Planning Horizon: The Long Run
Short run
Operating period
Fixed costs - firm is constrained
Long run
Planning period
Time period just long enough that everything is variable
No fixed costs
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24. The Planning Horizon: The Long Run
Manager - can choose any size of plant or building
Any combination of other resources
Planning
Manager compares all short-run situations
Expand, contract, relocate, enter a new business, exit any line of business, or quit doing business altogether
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25. Figure 13.3 Morita’s Long-Run Average Total Cost Curve
The company is currently operating at 5,000 units of output per year. To increase to 100,000 would require an increase in the capacity or scale of the firm.
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26. Figure 13.4 The Long-Run and Short Run Average Total Cost Curves
Producing 5,000 units can be done efficiently using the capacity of short-run average total cost (SRATC1). To generate 100,000 units per year would require an increase in scale. But once having increased scale to SRATC2, it would be virtually impossible—very expensive—to move back to 5,000 units.
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27. Costs in the Long Run Long run Is a planning period
Any combination of resources can be selected
A firm can choose to operate at any size
Choose the level of output it wants to produce
Then select the least-cost combination of resources with which to produce the chosen output level
Once it has built that given capacity, then it is constrained to operate at that level
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28. Economies and Diseconomies of Scale
Cost per unit of output decreases as output rises
Diseconomies of scale
Cost per unit of output increases when the quantity of production increases
Constant returns to scale
Cost per unit of output is constant as output rises
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29. Economies and Diseconomies of Scale
Long-run average total cost curve
Downward sloping
Economies of scale
Constant
Constant returns to scale
Upward sloping
Diseconomies of scale
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30. Economies and Diseconomies of Scale
Economies of scale - result from
Ability to use larger machines that are more efficient than small ones
Specialization
Primary reason for diseconomies of scale
Managerial inefficiencies
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31. Large Scale Is Not Always Best
Efficiency and specialization
Are limited by the size of the market
Larger firm – produce more than what the market can buy
Inefficient
Larger size
Not necessarily beneficial for individual firms
Diseconomies of scale - Bureaucracy, quarterly reporting, rent seeking
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32. Economies of Scope Economies of scope
Firm obtains a production advantage from producing more than one product
The cost of producing two (or more) products jointly is less than the cost of producing each one alone
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33. Economies of Scope Economies of scope Advantages may arise:
Production facility used to make one product - can also be used to make another
By-products of one product - useful in the production of another product
People trained to produce one product - can use their training in the production of another product
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34. The Experience Curve Experience curve, learning curve
Declining costs as output rises
The result of learning, of gaining experience
Confused with economies of scale
Aircraft manufacturers
Learning curve
Broiler chickens
Misleading learning curve
Better technology
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35. Figure 13.5 The Experience Curve
If the more experience a firm has in producing a particular good results in lower per-unit costs, then the firm has an experience, or learning curve, that slopes downward. In this diagram, experience curves for two industries are shown, one for aircraft and one for chickens.
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