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The Firm and Cost Overheads. Costs in the short run Total cost — everything they must give up in order to produce output A firm’s total cost of production.

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Presentation on theme: "The Firm and Cost Overheads. Costs in the short run Total cost — everything they must give up in order to produce output A firm’s total cost of production."— Presentation transcript:

1 The Firm and Cost Overheads

2 Costs in the short run Total cost — everything they must give up in order to produce output A firm’s total cost of production is the opportunity cost of the owners

3 Explicit and implicit costs Explicit costs 1.purchase of expendable inputs including labor time 2.purchase of capital services (usually rent or lease) Implicit costs 1.value of produced expendables (feed for a cattle producer) 2.value of services provided by owned capital including financial capital

4 Operating costs and allocated overhead 1.Costs of all expendables are often allocated OPERATING COSTS to the generic group OPERATING COSTS 2.All other costs are allocated to the group ALLOCATED OVERHEAD

5 Data for the hay hauling problem Cost of labor per hour = w 1 = $6.00 Cost of tractor-wagon per hour = w 2 = $20.00

6 Total fixed cost (TFC) The cost of all inputs that are fixed in the short run are called total fixed costs Assume that wagons hours is fixed at 1 For this example, then TFC = $20.00

7 Fixed Cost Curve 0 20 40 60 80 100 04008001200160020002400 Cost Output - y TFC Graphical representation

8 x 1 x 2 TPPAPP A MPPMPPTFCTVCTCAFCAVCATCAMCMC 0.00 1.00 0.00 0.00 20.0 0.00 20.00 Data on hay hauling 1.0 1.0 38.0 38.00 38.00 74.0 20.0 6.00 26.00 0.5260.1580.6840.1580.081 2.0 1.0 144.0 72.00 106.00 136.0 20.0 12.00 32.00 0.1390.0830.2220.0570.044 3.0 1.0 306.0 102.00 162.00 186.020.0 18.00 38.00 0.0650.0590.1240.0370.032 Fixed cost stays the same -- variable cost is rising

9 x 1 x 2 TPPAPP A MPPMPPTFCTVCTCAFCAVCATCAMCMC 0.00 1.00 0.00 0.00 20.0 0.00 20.00 Data on hay hauling 1.0 1.0 38.0 38.00 38.00 74.0 20.0 6.00 26.00 0.5260.1580.6840.1580.081 2.0 1.0 144.0 72.00 106.00 136.0 20.0 12.00 32.00 0.1390.0830.2220.0570.044 3.0 1.0 306.0 102.00 162.00 186.020.0 18.00 38.00 0.0650.0590.1240.0370.032 4.01.0512.0128.00 206.00 224.0 20.0 24.00 44.00 0.0390.0470.0860.0290.027 5.01.0750.0150.00 238.00 250.0 20.0 30.00 50.00 0.0270.0400.0670.0250.024 6.01.01008.0168.00 258.00 264.0 20.0 36.00 56.00 0.0200.0360.0560.0230.023 7.01.01274.0182.00 266.00 266.0 20.0 42.00 62.00 0.0160.0330.0490.0230.023 8.01.01536.0192.00 262.00 256.0 20.0 48.00 68.00 0.0130.0310.0440.0230.023 9.01.01782.0198.00 246.00 234.0 20.0 54.00 74.00 0.0110.0300.0420.0240.026 10.01.02000.0200.00 218.0 200.0 20.0 60.00 80.0 0.0100.0300.0400.0280.030 11.01.02178.0198.00 178.0 154.0 20.0 66.00 86.0 0.0090.0300.0390.0340.039 12.01.02304.0192.00 126.0 96.0 20.0 72.00 92.0 0.0090.0310.0400.0480.063 13.01.02366.0182.00 62.0 26.0 20.0 78.00 98.0 0.0080.0330.0410.0970.231 14.01.02352.0168.00 -14.0 -56.0 20.0 84.00 104.0 0.0090.0360.044

10 Total variable cost (TVC) Remember that the cost of all the inputs that are variable in the short run is called total variable cost For our example TVC(38) = $6.00

11 And TVC (306) = $18.00 Data on hay hauling x 1 x 2 TPPAPP A MPPMPPTFCTVCTCAFCAVCATCAMCMC 0.00 1.00 0.00 0.00 20.0 0.00 20.00 1.01.038.038.00 38.00 74.0 20.0 6.00 26.00 0.5260.1580.6840.1580.081 2.01.0144.072.00 106.00 136.0 20.0 12.00 32.00 0.1390.0830.2220.0570.044 3.01.0306.0102.00 162.00 186.020.0 18.00 38.00 0.0650.0590.1240.0370.032

12 Data on hay hauling x 1 x 2 TPPAPP A MPPMPPTFCTVCTCAFCAVCATCAMCMC 0.00 1.00 0.00 0.00 20.0 0.00 20.00 1.01.038.038.00 38.00 74.0 20.0 6.00 26.00 0.5260.1580.6840.1580.081 2.01.0144.072.00 106.00 136.0 20.0 12.00 32.00 0.1390.0830.2220.0570.044 3.01.0306.0102.00 162.00 186.020.0 18.00 38.00 0.0650.0590.1240.0370.032 4.01.0512.0128.00 206.00 224.0 20.0 24.00 44.00 0.0390.0470.0860.0290.027 5.01.0750.0150.00 238.00 250.0 20.0 30.00 50.00 0.0270.0400.0670.0250.024 6.01.01008.0168.00 258.00 264.0 20.0 36.00 56.00 0.0200.0360.0560.0230.023 7.01.01274.0182.00 266.00 266.0 20.0 42.00 62.00 0.0160.0330.0490.0230.023 8.01.01536.0192.00 262.00 256.0 20.0 48.00 68.00 0.0130.0310.0440.0230.023 9.01.01782.0198.00 246.00 234.0 20.0 54.00 74.00 0.0110.0300.0420.0240.026 10.01.02000.0200.00 218.0 200.0 20.0 60.00 80.0 0.0100.0300.0400.0280.030 11.01.02178.0198.00 178.0 154.0 20.0 66.00 86.0 0.0090.0300.0390.0340.039 12.01.02304.0192.00 126.0 96.0 20.0 72.00 92.0 0.0090.0310.0400.0480.063 13.01.02366.0182.00 62.0 26.0 20.0 78.00 98.0 0.0080.0330.0410.0970.231 14.01.02352.0168.00 -14.0 -56.0 20.0 84.00 104.0 0.0090.0360.044

13 Graphical representation of TVC Total Variable Cost 0 20 40 60 80 100 04008001200160020002400 Cost Output - y TVC

14 Total cost (TC) The cost of all inputs used by the firm is called total costs TC = TFC + TVC Specifically, the sum of fixed and variable costs is called total costs

15 Cost function

16 Graphical representation of total cost (TC) Total Cost Curves 0 20 40 60 80 100 04008001200160020002400 Cost Output - y TFC TVC TC

17 Average cost (AC) Average cost is just a total cost figure divided by the associated output level AC represents the average per unit cost of a given level of output There are average costs associated with each level of total costs

18 Average fixed cost is given by Average variable cost is given by Average (total) cost is given by

19 Data on hay hauling x 1 x 2 TPP(y)APP A MPPMPPTFCTVCTCAFCAVCATCAMCMC 0.00 1.00 0.00 0.00 20.0 0.00 20.00 1.01.038.038.00 38.00 74.00 20.0 6.00 26.00 0.5260.1580.6840.1580.081 2.01.014472.00 106.0 136.0 20.0 12.0 32.0 0.1390.0830.2220.0570.044 3.01.0306.0102.00 162.00 186.00 20.0 18.00 38.00 0.0650.0590.1240.0370.032 4.01.0512.0128.00 206.00 224.00 20.0 24.00 44.00 0.0390.0470.0860.0290.027 5.01.0750.0150.00 238.00 250.00 20.0 30.00 50.00 0.0270.0400.0670.0250.024 6.01.01008.0168.00 258.00 264.00 20.0 36.00 56.00 0.0200.0360.0560.0230.023 7.01.01274.0182.00 266.00 266.00 20.0 42.00 62.00 0.0160.0330.0490.0230.023 8.01.01536.0192.00 262.00 256.00 20.0 48.00 68.00 0.0130.0310.0440.0230.023 9.01.01782.0198.00 246.00 234.00 20.0 54.00 74.00 0.0110.0300.0420.0240.026 10.01.02000.0200.00 218.0 200.00 20.0 60.00 80.0 0.0100.0300.0400.0280.030 11.01.02178.0198.00 178.0 154.00 20.0 66.00 86.0 0.0090.0300.0390.0340.039 12.01.02304.0192.00 126.0 96.00 20.0 72.00 92.0 0.0090.0310.0400.0480.063 13.01.02366.0182.00 62.0 26.00 20.0 78.00 98.0 0.0080.0330.0410.0970.231 14.01.02352.0168.00 -14.0 -56.00 20.0 84.00 104.0 0.0090.0360.044

20 Average Fixed Cost 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 04008001200160020002400 Cost Output - y AFC

21 AVC Average Variable Cost 0.00 0.05 0.10 0.15 0.20 04008001200160020002400 Cost Output - y

22 Note that ATC = AVC + AFC Average Cost Curves 0.00 0.10 0.20 0.30 0.40 04008001200160020002400 Cost Output - y AVC ATC AFC

23 Marginal cost Marginal cost is the increment, or addition, to cost that results from producing one more unit of output The increase in total cost is the increase in variable cost In discrete or average terms marginal cost is given by

24 Marginal cost is just the derivative of the cost function with respect to y

25 Example calculation x 1 x 2 yTFCTVCTCAVE MC 0.01.00.020.0 0.00 20.00 1.01.038.020.0 6.00 26.00 0.158 2.01.0144.020.0 12.00 32.00 0.057 3.01.0306.020.0 18.00 38.00 0.037 4.01.0512.020.0 24.00 44.00 0.029 5.01.0750.020.0 30.00 50.00 0.025 6.01.01008.020.0 36.00 56.00 0.023

26 Graphical representation of Marginal Cost 0.00 0.05 0.10 0.15 0.20 04008001200160020002400 Cost Output - y AVE MC

27 Relationship between MC & MPP (1 variable input) When MPP rises, MC falls When MPP falls, MC rises Marginal Cost Curve 0.00 0.05 0.10 0.15 0.20 04008001200160020002400 Cost Output - y AVE MC Marginal Product of Input 1 -50 0 50 100 150 200 250 300 2468101214 Input - x 1 Output - y MPP 1

28 4.The marginal cost curve will intersect AVC and ATC at their minimum points Average and marginal costs 1.When marginal cost is below the average cost, the average cost curve is falling 2.When the marginal and average costs are equal, the average cost curve does not change (is at minimum point) 3.When the marginal cost is greater than average cost, average cost is rising

29 Average and Marginal Cost Curves 0.0 0.1 0.2 0.3 04008001200160020002400 Cost Output - y AVC ATC AVE MC AFC

30 FC Cost curves for alternative function 0 50 100 150 200 250 300 350 400 450 500 010203040 Output - y Cost VC TC

31 AVC ATC AFC Average and Marginal Cost Curves 0 4 8 12 16 20 24 28 32 36 40 0102030 Output - y Cost AMC

32 The End

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