1. BU224: Microeconomics Unit 6 Seminar Tutor Center: http://khe2.acrobat.com/kubc/ http://khe2.acrobat.com/kubc/ (Check the Business Tutor Center Link) Greg Evans, PhD

2. Unit 6 Seminar Agenda Chapter 11: Behind the Supply Curve: Inputs and Costs “Theory of Production and Costs” “Production, Costs and Supply”

3. Behind the Supply Curve: Inputs and Costs The various types of costs a firm faces Goals: – Understand how a profit-maximizing firm chooses the optimal quantity of output – Understand the costs of production relationships between input and output

4. The Production Function The purpose of a firm is to turn inputs into outputs A production function is the relationship between the quantity of inputs a firm uses and the quantity of output it produces Output = f(labor, capital, inputs, technology)

5. Inputs and Output: Short run and Long run The short run: the time period in which at least one input is fixed. (fixed inputs + variable inputs) The long run: the time period in which all inputs can be varied. (all inputs are variable inputs) Short run and long run varies from firm to firm

6. Fixed Inputs vs. Variable Inputs In the Short run a firm faces: – A fixed input is an input whose quantity is fixed for a period of time and cannot be varied – Variable inputs: resources that can change in quantity depending on the level of output being produced

7. Production and Costs A fixed cost is a cost that does not depend on the quantity of output produced. It is the cost of the fixed input A variable cost is a cost that depends on the quantity of output produced. It is the cost of the variable input – Cost minimization generally involves variable costs Cost minimization leads to profit maximization

8. Total Costs of Production The total cost (TC) of producing a given quantity of output is the sum of the fixed cost (FC) and the variable cost (VC) of producing that quantity of output TC = FC + VC

9. Fixed, variable and total costs of production for a firm Output (Q)VC*FCTC (‘000) 00$30$30 1$103040 2253055 3453075 47030100 510030130 613530165 * VC = Labor needed to produce Q * price of labor (wage rate)

10. Average Total Cost Average total cost (ATC) is total cost of production divided by the quantity of output produced Total Cost/Quantity of Output ATC = TC/Q

11. Average Total Cost (ATC) Output (Q)TC (VC+FC)ATC (TC/Q) 0$30-- 14040 25527.5 37525 410025 513026 616527.5

12. Profit maximization and the output decision The rule for determining whether a firm is profitable depends on a comparison of the peer unit market price (P) or the marginal revenue of the good to the firm’s break even price – If P>ATC, the firm earns a profit – If P=ATC, the firm breaks even – If P<ATC, the firm incurs a loss A firm’s break even price: minimum average total cost (ATC) Minimum-cost output: it is the quantity of output level where the firm incurs the lowest ATC Note the output levels of 3 and 4 with ATC=$25 in table

13. Average Fixed Cost & Average Variable Cost Average fixed cost: fixed cost per unit of output Fixed Cost / Quantity of Output AFC = FC/Q Average variable cost: variable cost per unit of output Variable Cost / Quantity of Output AVC = VC/Q

14. Average Fixed Cost (AFC) OutputFCAFC (FC/Q) 0$30-- 13030 23015 33010 4307.5 5306 6305

15. Average Variable Cost OutputVCAVC (VC/Q) 00-- 1$1010 22512.5 34515 47017.5 510020 613522.5

16. Various Costs of the Firm QVCFCTCAVCAFCATC 00$30$30------ 1$103040103040 225305512.51527.5 3453075151025 4703010017.57.525 51003013020626 61353016522.5527.5

17. Marginal Cost of Production Change in total cost of production for a one unit increase in production quantity Change in Total Cost / Change in Quantity

18. Computing Marginal Cost of Production QTCMC 0$30-- 14010 25515 37520 410025 513030 616535

19. Questions???