1. Production Costs
Chapter 9
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2. Economic or Opportunity Cost
The value or worth the resource would have in its best alternative use.
Remember the pizza robots example??? Opportunity cost of producing more pizzas is the robots that are not produced.
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3. Economic Costs
Payments a firm must make to attract the resources it needs away from alternative production opportunities.
Two types of economic costs: explicit & implicit
These are explicit or implicit payments which will be discussed in the next slide.
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4. Explicit Costs
Cash payments a firm makes to those who supply labor services, materials, fuel, & transportation services.
These payments are for the use of resources owned by others.
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5. Implicit Costs
Opportunity cost of self-owned, self-employed resources.
These costs are the payments that self-employed resources could have earned in their best alternative use.
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6. Accounting & Economic Profit
Accounting (Normal)- Cost of doing business. Total revenue – explicit (accounting) costs
Economic Profit
= total revenue – economic costs
Economic costs are explicit and implicit.
Do example on page 158.
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7. Total accounting profit = 57,000
Total sales revenue: $120,000
Cost of t-shirts: $40,000
Clerk’s salary: $18,000
Utilities: $5,000
Total explicit costs = 63,000
Total accounting profit = 57,000
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8. Forgone entrepreneurial income: 5,000 Implicit costs (total) = 33,000
Accounting profit = $57,000
Forgone interest: 1,000
Forgone rent: 5,000
Forgone wages: 22,000
Forgone entrepreneurial income: 5,000
Implicit costs (total) = 33,000
Economic profit = 24,000
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9. Short Run Period too brief for a firm to alter its plant capacity
Period long enough to permit a change in the degree to which the fixed plant is used.
The firm can vary its output by applying different amounts of resources to the plant.
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10. Long Run
Period long enough to adjust the quantities of all the resources it employs, including plant capacity.
In the long run, existing firms can dissolve and leave the industry…new firms can enter as well.
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11. Short-Run Production Relationships
Total Product (TP)- total quantity (output) of a particular good produced.
Marginal Product (MP)- extra output or added product associated with adding a unit of a variable resource to the production process.
Average Product (AP)- output per unit of labor (TP/labor)
Read first: a firm’s costs of producing something depends on the prices of the resources needed and how much is needed to produce the product.
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12. Law of Diminishing Returns
As more units of a variable resource (I.e. labor) are added to a fixed resource (I.e. land)…
The marginal product attributed to each additional unit of the variable resource will decline.
Do table 9.1 on board page 161…also do key graph on page 162
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13. Average Product (TP/Labor)
Key Graph
Resource
Units
Total Product
Marginal Product
Average Product (TP/Labor)
--- 1 10 2 25 3 45 4 60 5 70 6 75 7 8
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14. Short-Run Production Costs
Fixed costs- those costs that do not vary with changes in output (I.e. rent).
Variable costs- those costs that change with the level of output (I.e. materials & labor).
Total costs- sum of fixed & variable at each level of output.
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15. Per-Unit or Average Costs
Average fixed costs (afc)- total fixed cost/output.
Average variable costs (avc)- total variable/output.
Average total costs (atc)- afc + avc
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16. Marginal cost (mc)
Extra or additional cost of producing one more unit of output.
Complete table 9.2 on page 163 and key graph figure 9.5 on page 166
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17. Key Graph TFC TVC TC MC AFC AVC ATC 100 --- 1 90 2 170 3 240 4 300 5
Total Product
TFC
TVC TC
TFC+TVC MC
ΔTC
AFC
TFC/TP
AVC
TVC/TP
ATC
AFC+AVC or TC/TP
100
--- 1 90 2
170 3
240 4
300 5
370 6
450 7
540 8
650 9
780 10
930
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18. Graphs
MC curve declines sharply at first, reaches a minimum, and then rises quickly.
Why??? Variable & total costs increase rather dramatically as more of a product is produced.
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19. Relation of MC to AVC & ATC
MC intersects both the AVC & ATC at their minimum point.
2) Baseball ERA analogy.
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20. Long-Run Cost Curve
Vertical lines perpendicular to the atc curves lowest point create a portion of the long run average total cost curve.
This long-run curve is made up of segments of short-run atc curves.
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21. Economies of Scale
Reductions in the average total cost of producing a product as the firm expands the size of plant in the long run (mass production).
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22. Diseconomies of Scale
Increases in the average total cost of producing a product as the firm expands in size of its plant in the long run.
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23. Minimum Efficient Scale (MES)
Lowest level of output at which a firm can minimize long-run average costs.
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24. Natural monopoly
Average total cost is minimized when one firm produces the good or service
This does not happen often
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