1. Chapter 8 Production and Costs

2. Marginal Physical Product (MPP)
What is the variable input?
What is the variable cost?

3. So…
As more labor (VARIABLE INPUT) are added to land (FIXED INPUT) the variable inputs would yield smaller and smaller additions to output

4. Marginal Physical Product

5. Crowding Problem The point at which MPP declines
Shows the law of diminishing returns

6. Average Physical Productivity
Output divided by Inputs (usually labor)
Good for comparing firms or countries.

7. So find that…
MC and MPP are related
What is the relationship?

8. In –class exercise 10 Does MPP show Diminishing Returns???

9. Law of Diminishing Marginal Returns

10. Marginal Cost

11. Does this relationship make sense?
Yes..
If productivity increases what would happen to costs??
Decrease (MPP increase & MC decrease)
Productivity decreases??
Increase (MPP decreases & MC increases)

12. MPP determines shape of MC
MPP must have a declining part because of diminishing returns
Can also define MC as:

13. How do we calculate these costs?? Give two ways to get to the cost…
In-class exercise 11
How do we calculate these costs??
Give two ways to get to the cost…

14. Average-Marginal Rule
Can use to see what the ATC and AVC curve look like
Tells us what happens when MC is above or below the “average” curves
If MC is above AVC and ATC
AVC and ATC are rising
If MC is below AVC and ATC
AVC and ATC are falling

15. From Average-Marginal Rule can infer…
MC intersects the AVC and ATC curves at their MINIMUM POINTS
Cannot infer anything about AFC

16. Average and Marginal Cost Curves

17. Average and Marginal Cost Curves

18. So… MC gains it shape from??? MC below ATC: What is ATC curve doing?
MPP and law of diminishing marginal returns
MC below ATC: What is ATC curve doing?
Falling
MC above ATC: What is ATC curve doing?
Rising

19. Average and Marginal Cost Curves

20. Tying Products to Costs
A CLOSER LOOK
MPP
Variable Input
When MC is below
ATC, AVC MC
Production in the
short run: at
least one fixed input
When MC is above
ATC, AVC
MPP
Variable Input MC

21. Now switching to the Long Run
When does Long Run start?
As soon as all inputs (costs) are VARIABLE
No fixed costs
Important curves
LRTC
LRATC
LRMC

22. Short Run vs. Long Run Short Run assumes FIXED plant size
Each plant size has a unique ATC curve associated with it
SRATC
LRATC combines all the SRATC curves
Which points of the SRATC???
Minimum points

23. Why minimum?
LRATC shows the lowest average cost at which a firm can produce any given level of output
LRATC is the lower ENVELOPE of the SRATC curves
Called envelope curve

24. Long-Run Average Total Cost Curve (LRATC)

25. Isn’t the LRATC curve smooth??
Yes!!
Have infinitely many SRATC curves so it would be smooth if use all curves
Each SRATC curve touches the LRATC curve only once

26. Shape of LRATC U-shaped Decreasing, Flat, then Increasing
Important when finding optimal long run output level

27. Long-Run Average Total Cost Curve (LRATC)

28. Economies of Scale Downward part of LRATC
Average costs decrease as output increases
If have a 1% increase in input usage what happens to output??
Increases by MORE than 1%
Specialization

29. Constant Returns to Scale
Flat portion of LRATC
Costs remain the same as increase output
If have a 1% increase in input usage what happens to output??
Output increases by EXACTLY 1%
First point of constant returns to scale is called MINIMUM EFFICIENT SCALE

30. Diseconomies of Scale Upward sloped portion of LRATC
Costs are rising as we increase output
If have a 1% increase in input usage what happens to output?
Increases by LESS THAN 1%
Why???
Firm too large (bad communication or coordination problems)

31. Long-Run Average Total Cost Curve (LRATC)

32. Are economies, diseconomies, and constant returns to scale in SR, LR, or both???
LONG RUN ONLY!!!
Why?
Inputs necessary for production are able to be changed
No fixed inputs

33. Is this the same as diminishing returns?NO
Diminishing returns is from using ONE plant size intensely
Short run
Economies of scale is from CHANGING plant size
Long run

34. Review Economies of Scale Constant Returns to Scale
LRATC falling
Constant Returns to Scale
LRATC flat
Diseconomies of Scale
LRATC rising

35. Why does economies of scale exist?
Large firms offer more opportunity for workers to specialize
Growing firms can take advantage of efficient mass production techniques
Smooth cost over more units produced

36. Why does diseconomies of scale exist?
Communication problems
Shirking
Management problems

37. Why is minimum efficient scale important?
Lowest output level at which ATC are minimized
Which has a cost advantage??
Small firm at minimum efficient scale point
Larger firm producing more output but still within constant returns to scale area
Neither

38. Long-Run Average Total Cost Curve (LRATC)

39. Minimum Efficient Scale for Six Industries

40. Where would you expect to find less firms? (using MES)
Firms with higher MES
Why??
Produce until MES
If MES is higher then each firm will be producing more…so need less firms to cover quantity wanted by economy
Many SHOE companies (MES = .2)
Few REFRIGERATOR companies (MES = 14)

41. Efficient Number of Firms
100 divided by MES
100% of goods are wanted by consumers
MES is the percentage of consumption each firm will provide
Cigarette firm’s MES = 6.6
Need 15 firms
Petroleum firm’s MES = 1.9
Need 52 firms
Thus a larger MES means less firms needed

42. What cause SRTC, LRTC, and MC to shift?
Taxes
Does it affect FC??
Only if it is a lump sum tax (tax for existing)
If it is a per unit tax then FC doesn’t change
How does it change curves??
Input prices
Technology
Either improves production process (use less inputs) or lower input prices

43. Homework Chapter 8 Working with numbers and graphs
Questions: 3, 5, 10, and 11
Working with numbers and graphs
Questions 3, 6, and 7

44. Do we understand Chapter 8??
In-class exercise 12
Do we understand Chapter 8??