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© 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien c h a p t e r seven Prepared by: Fernando &

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Presentation on theme: "© 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien c h a p t e r seven Prepared by: Fernando &"— Presentation transcript:

1 © 2007 Prentice Hall Business Publishing Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien c h a p t e r seven Prepared by: Fernando & Yvonn Quijano Technology, Production, and Costs

2 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 2 of 31 After studying this chapter, you should be able to: Define technology and give examples of positive and negative technological change. Distinguish between the economic short run and the economic long run. Understand the relationship between the marginal product of labor and the average product of labor. Explain and illustrate the relationship between marginal cost and average total cost. Graph average total cost, average variable cost, average fixed cost, and marginal cost. Understand how firms use the long-run average cost curve to plan. Sony Uses a Cost Curve to Determine the Price of Radios LEARNING OBJECTIVES 1 2 3 4 5 In this chapter, we will focus on the relationship between a firm’s technology and its production costs. 6

3 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 3 of 31 Technology: An Economic Definition LEARNING OBJECTIVE 1 Technology The processes a firm uses to turn inputs into outputs of goods and services. Technological change A change in the ability of a firm to produce a given level of output with a given quantity of inputs.

4 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 4 of 31 The Short Run and the Long Run Short run The period of time during which at least one of the firm’s inputs is fixed. Long run A period of time long enough to allow a firm to vary all of its inputs, to adopt new technology, and to increase or decrease the size of its physical plant. LEARNING OBJECTIVE 2

5 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 5 of 31 The Short Run and the Long Run The Difference between Fixed Costs and Variable Costs Total cost The cost of all the inputs a firm uses in production. Variable costs Costs that change as output changes. Fixed costs Costs that remain constant as output changes. Total Cost = Fixed Cost + Variable Cost TC = FC + VC

6 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 6 of 31 The Short Run and the Long Run Implicit Costs versus Explicit Costs Opportunity cost The highest-valued alternative that must be given up to engage in an activity. Explicit cost A cost that involves spending money. Implicit cost A nonmonetary opportunity cost.

7 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 7 of 31 The Short Run and the Long Run The Production Function Jill Johnson’s Costs per Year 7 – 1 Paper Wages Lease payment for copy machines Electricity Lease payment for store Foregone salary Foregone interest Total $20,000 $48,000 $10,000 $6,000 $24,000 $30,000 $3,000 $141,000 Production Function The relationship between the inputs employed by the firm and the maximum output it can produce with those inputs.

8 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 8 of 31 The Short Run and the Long Run A First Look at the Relationship Between Production and Cost Short-Run Production and Cost at Jill Johnson’s Copy Store 7 – 2 QUANTITY OF WORKERS QUANTITY OF COPY MACHINES QUANTITY OF COPIES COST OF COPY MACHINES (FIXED COST) COST OF WORKERS (VARIABLE COST) TOTAL COST OF COPIES COST PER COPY (AVERAGE COST) 01234560123456 22222222222222 0 625 1325 2200 2600 2900 3100 $25 25 $0 50 100 150 200 250 300 $25 75 125 175 225 275 325 - $0.12 0.09 0.08 0.09 0.10 0.11 Average total cost Total cost divided by the quantity of output produced.

9 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 9 of 31 The Short Run and the Long Run A First Look at the Relationship Between Production and Cost 7 - 1 Graphing Total cost and Average Total Cost at Jill Johnson’s Photocopy Store

10 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 10 of 31 The Marginal Product of Labor and the Average Product of Labor LEARNING OBJECTIVE 3 Marginal product of labor The additional output a firm produces as a result of hiring one more worker. The Law of Diminishing Returns Law of diminishing returns The principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable to decline.

11 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 11 of 31 The Law of Diminishing Returns QUANTITY OF WORKERS QUANTITY OF COPY MACHINES QUANTITY OF COPIES MARGINAL PRODUCT OF LABOR 01234560123456 22222222222222 0 625 1,325 2,200 2,600 2,900 3,100 - 625 700 875 400 300 200 Marginal and Average Product of Labor at Jill Johnson’s Copy Store 7 – 3 The Marginal Product of Labor and the Average Product of Labor

12 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 12 of 31 Graphing Production 7 - 2 Total Output and the Marginal Product of Labor The Marginal Product of Labor and the Average Product of Labor

13 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 13 of 31 The Relationship between Marginal and Average Product Average product of labor The total output produced by a firm divided by the quantity of workers. The Marginal Product of Labor and the Average Product of Labor

14 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 14 of 31 An Example of Marginal and Average Values: College Grades 7 - 3 Marginal and Average GPAs The Marginal Product of Labor and the Average Product of Labor

15 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 15 of 31 The Relationship Between Short-Run Production and Short-Run Cost LEARNING OBJECTIVE 4 Marginal Cost Marginal Cost The change in a firm’s total cost from producing one more unit of a good or service.

16 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 16 of 31 Why Are the Marginal and Average Cost Curves U-Shaped? 7 - 4 Jill Johnson’s Marginal Cost and Average Cost of Producing Copies The Relationship Between Short-Run Production and Short-Run Cost

17 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 17 of 31 The Relationship Between Marginal Cost and Average Cost 7 - 1 LEARNING OBJECTIVE 4

18 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 18 of 31 Graphing Cost Curves Average fixed cost Fixed cost divided by the quantity of output produced. Average variable cost Variable cost divided by the quantity of units produced. Average total cost = ATC = TC/Q Average fixed cost = AFC = FC/Q Average variable cost = AVC = VC/Q ATC = AFC + AVC LEARNING OBJECTIVE 5

19 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 19 of 31 Graphing Cost Curves 7 - 5 Costs at Jill Johnson’s Copy Store

20 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 20 of 31 Costs in the Long Run LEARNING OBJECTIVE 6 Economies of Scale Long-run average cost curve A curve showing the lowest cost at which the firm is able to produce a given quantity of output in the long run, when no inputs are fixed. Economies of scale Economies of scale exist when a firm’s long-run average costs fall as it increases output.

21 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 21 of 31 Costs in the Long Run Economies of Scale Constant returns to scale Constant returns to scale exist when a firm’s long-run average costs remain unchanged as it increases output. Minimum efficient scale The level of output at which all economies of scale have been exhausted. Diseconomies of scale Exist when a firm’s long-run average costs rise as it increases output.

22 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 22 of 31 Costs in the Long Run Long-Run Average Total Cost Curves for Bookstores 7 - 6 The Relationship between Short-Run Average Cost and Long-Run Average Cost

23 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 23 of 31 Using Long-Run Average Cost Curves to Understand Business Strategy 7 - 2 LEARNING OBJECTIVE 6

24 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 24 of 31 The Colossal River Rouge: Diseconomies of Scale at the Ford Motor Company 7 - 4 Is it possible for a factory to be too big?

25 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 25 of 31 Don’t Confuse Diminishing Returns with Diseconomies of Scale

26 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 26 of 31 Conclusion A Summary of Definitions of Cost 7 – 4 TERMDEFINITION SYMBOLS AND EQUATIONS Total costThe value of all the inputs used by a firm TC Fixed costCosts that remain constant when a firm’s level of output changes FC Variable costCosts that change when the firm’s level of output changes VC Marginal costThe increase in total cost resulting from producing another unit of output Average total costTotal cost divided by the quantity of units produced Average fixed costFixed cost divided by the quantity of units produced Average variable cost Variable cost divided by the quantity of units produced Implicit costA nonmonetary opportunity cost - Explicit costA cost that involves spending money-

27 © 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 7: Technology, Production, and Costs 27 of 31 Average fixed cost Average variable cost Average product of labor Average total cost Constant returns to scale Diseconomies of scale Economies of scale Explicit cost Fixed costs Implicit cost Law of diminishing returns Long run Long-run average cost curve Marginal cost Marginal product of labor Minimum efficient scale Opportunity cost Production function Short run Technological change Technology Total cost Variable costs

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