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Chapter 8. The Meaning of Costs Opportunity costsOpportunity costs Measuring a firm’s opportunity costsMeasuring a firm’s opportunity costs –factors not.

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Presentation on theme: "Chapter 8. The Meaning of Costs Opportunity costsOpportunity costs Measuring a firm’s opportunity costsMeasuring a firm’s opportunity costs –factors not."— Presentation transcript:

1 Chapter 8

2 The Meaning of Costs Opportunity costsOpportunity costs Measuring a firm’s opportunity costsMeasuring a firm’s opportunity costs –factors not owned by the firm: explicit costs –factors already owned by the firm: implicit costs –irrelevance of historic costs and replacement costs

3 Production in the Short run Production functionsProduction functions Long-run and short-run production:Long-run and short-run production: –fixed and variable factors The law of diminishing returnsThe law of diminishing returns The short-run production function:The short-run production function: –total physical product (TPP)

4 Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 40

5 Number of farm workers Tonnes of wheat produced per year TPP Wheat production per year from a particular farm

6 Number of farm workers Tonnes of wheat produced per year TPP a b Diminishing returns set in here Wheat production per year from a particular farm

7 Number of farm workers Tonnes of wheat produced per year TPP a b d Maximum output Wheat production per year from a particular farm

8 Production in the Short run Production functionsProduction functions Long-run and short-run production:Long-run and short-run production: –fixed and variable factors The law of diminishing returnsThe law of diminishing returns The short-run production function:The short-run production function: –total physical product (TPP) –average physical product (APP)

9 Production in the Short run Production functionsProduction functions Long-run and short-run production:Long-run and short-run production: –fixed and variable factors The law of diminishing returnsThe law of diminishing returns The short-run production function:The short-run production function: –total physical product (TPP) –average physical product (APP) –marginal physical product (MPP)

10 Production in the Short run Production functionsProduction functions Long-run and short-run production:Long-run and short-run production: –fixed and variable factors The law of diminishing returnsThe law of diminishing returns The short-run production function:The short-run production function: –total physical product (TPP) –average physical product (APP) –marginal physical product (MPP) –the graphical relationship between TPP, APP and MPP

11 Wheat production per year from a particular farm Number of farm workers (L) Tonnes of wheat per year TPP Tonnes of wheat per year Number of farm workers (L)  TPP = 7  L = 1 MPP =  TPP /  L = 7

12 Tonnes of wheat per year TPP Tonnes of wheat per year MPP Number of farm workers (L) Number of farm workers (L) Wheat production per year from a particular farm

13 Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP APP = TPP / L Number of farm workers (L) Number of farm workers (L) Wheat production per year from a particular farm

14 Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b Diminishing returns set in here Number of farm workers (L) Number of farm workers (L) b Wheat production per year from a particular farm

15 Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b d d Number of farm workers (L) Number of farm workers (L) Maximum output b Wheat production per year from a particular farm

16 Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c Wheat production per year from a particular farm

17 Costs in the Short run Costs and inputsCosts and inputs –costs and the productivity of factors –costs and the price of factors Fixed costs and variable costsFixed costs and variable costs Total costsTotal costs –total fixed cost (TFC) –total variable cost (TVC) –total cost (TC = TFC + TVC)

18 Total costs for firm X TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12

19 TV C TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 0 10 16 21 28 40 60 91 Total costs for firm X

20 TC TV C TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 Total costs for firm X

21 TV C TFC Diminishing marginal returns set in here TC Total costs for firm X

22 Costs in the Short run Marginal costMarginal cost –marginal cost (MC) and the law of diminishing returns –the relationship between the marginal and total cost curves

23 Marginal cost Output (Q) Costs (£) MC x

24 Costs in the Short run Marginal costMarginal cost –marginal cost (MC) and the law of diminishing returns –the relationship between the marginal and total cost curves Average costAverage cost –average fixed cost (AFC) –average variable cost (AVC) –average (total) cost (AC)

25 Costs in the Short run Marginal costMarginal cost –marginal cost (MC) and the law of diminishing returns –the relationship between the marginal and total cost curves Average costAverage cost –average fixed cost (AFC) –average variable cost (AVC) –average (total) cost (AC) Relationship between average and marginal costRelationship between average and marginal cost

26 Average and marginal costs Output (Q) Costs (£) MC x

27 Output (Q) Costs (£) MC x AVC y Average and marginal costs

28 Output (Q) Costs (£) MC x y AFC AVC Average and marginal costs

29 Output (Q) Costs (£) AFC AVC MC x AC y z Average and marginal costs

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