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©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 7 Microeconomics, Chapter 71 The Organization and Costs of Production AFC AVC ATC MC SLIDES PREPARED.

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Presentation on theme: "©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 7 Microeconomics, Chapter 71 The Organization and Costs of Production AFC AVC ATC MC SLIDES PREPARED."— Presentation transcript:

1 ©2005 McGraw-Hill Ryerson Ltd. Microeconomics, Chapter 7 Microeconomics, Chapter 71 The Organization and Costs of Production AFC AVC ATC MC SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE

2 ©2005 McGraw-Hill Ryerson Ltd.2 Microeconomics, Chapter 7 In this chapter you will learn 7.1 The various organizational forms a firm can take 7.2 What economic costs are 7.3 About a firm’s short-run production relationships 7.4 About a firm’s short-run production costs 7.5 The link between a firm’s size and costs in the long run

3 ©2005 McGraw-Hill Ryerson Ltd.3 Microeconomics, Chapter 7 Chapter 7 Topics 7.1 The Firm & the Business Sector 7.2 Economic Costs 7.3 Short-run Production Relationships 7.4 Short-run Production Costs 7.5 Long-run Production Costs

4 ©2005 McGraw-Hill Ryerson Ltd.4 Microeconomics, Chapter 7 The Firm & the Business Sector Different organizational structures: 1.Plant physicalestablishmentphysicalestablishment

5 ©2005 McGraw-Hill Ryerson Ltd.5 Microeconomics, Chapter 7 The Firm & the Business Sector Different organizational structures: 1.Plant 2.Firm business organization that owns & operates one or many plants business organization that owns & operates one or many plants

6 ©2005 McGraw-Hill Ryerson Ltd.6 Microeconomics, Chapter 7 The Firm & the Business Sector Different organizational structures: 1.Plant 2.Firm 3.Industry NOTES: horizontal combinationshorizontal combinations vertical combinationsvertical combinations conglomeratesconglomerates

7 ©2005 McGraw-Hill Ryerson Ltd.7 Microeconomics, Chapter 7 Legal Forms of Businesses 1.Sole Proprietorship 2.Partnership 3.Corporation advantages&disadvantages…advantages&disadvantages…

8 ©2005 McGraw-Hill Ryerson Ltd.8 Microeconomics, Chapter 7 Sole Proprietor PartnershipCorporationsetupeasyeasymoredifficult ownerautonomyhighlowerlowest access to capital lowesthigherhighest access to skills lowesthigherhighest liabilityunlimitedunlimitedlimited death of owner dissolvesdissolvescontinues corporations subject to double taxation

9 ©2005 McGraw-Hill Ryerson Ltd.9 Microeconomics, Chapter 7 owners hire managersowners hire managers ðconflict of interest stock options have not necessarily helpedstock options have not necessarily helped Enron, WorldComEnron, WorldCom 360 Networks, Nortel Networks360 Networks, Nortel Networks The Principal-Agent Problem

10 ©2005 McGraw-Hill Ryerson Ltd.10 Microeconomics, Chapter 7 Chapter 7 Topics 7.1 The Firm & the Business Sector 7.2 Economic Costs 7.3 Short-run Production Relationships 7.4 Short-run Production Costs 7.5 Long-run Production Costs

11 ©2005 McGraw-Hill Ryerson Ltd.11 Microeconomics, Chapter 7 Economic Costs......are Opportunity Costs

12 ©2005 McGraw-Hill Ryerson Ltd.12 Microeconomics, Chapter 7 Explicit Costs payments a firm must makepayments a firm must make Implicit Costs opportunity costs of firm’s own resourcesopportunity costs of firm’s own resources include normal profitsinclude normal profits Economic Costs

13 ©2005 McGraw-Hill Ryerson Ltd.13 Microeconomics, Chapter 7 Total Revenue $120,000 Cost of T -shirts $40,000 Clerk's salary $18,000 Utilities Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000 Normal Profit as a Cost

14 ©2005 McGraw-Hill Ryerson Ltd.14 Microeconomics, Chapter 7 Total Revenue $120,000 Cost of T -shirts $40,000 Clerk's salary $18,000 Utilities Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000 Normal Profit as a Cost Forgone interest $ 1,000 Forgone rent $ 5,000 Forgone wages $22,000 Normal profit $ 5,000 Totalimplicitcosts $ 3 3,000 Economic profit $ 24,000

15 ©2005 McGraw-Hill Ryerson Ltd.15 Microeconomics, Chapter 7 Normal Profit as a Cost Costs of production include all costsCosts of production include all costs –explicit & –implicit –including a normal profit required to attract & retain factors of production economic profit = total revenue – economic cost

16 ©2005 McGraw-Hill Ryerson Ltd.16 Microeconomics, Chapter 7 TotalRevenue Profits to an Economist Accountant Figure 7-1

17 ©2005 McGraw-Hill Ryerson Ltd.17 Microeconomics, Chapter 7 ExplicitCosts Accounting costs (explicit costs only) TotalRevenue Profits to an Economist Accountant Figure 7-1

18 ©2005 McGraw-Hill Ryerson Ltd.18 Microeconomics, Chapter 7 ExplicitCosts Accounting costs (explicit costs only) AccountingProfits TotalRevenue Profits to an Economist Accountant Figure 7-1

19 ©2005 McGraw-Hill Ryerson Ltd.19 Microeconomics, Chapter 7 Implicit costs (including a normal profit) ExplicitCosts Accounting costs (explicit costs only) AccountingProfits Economic (opportunity) Costs TotalRevenue Profits to an Economist Accountant Figure 7-1

20 ©2005 McGraw-Hill Ryerson Ltd.20 Microeconomics, Chapter 7 EconomicProfits Implicit costs (including a normal profit) ExplicitCosts Accounting costs (explicit costs only) AccountingProfits Economic (opportunity) Costs TotalRevenue Profits to an Economist Accountant Figure 7-1

21 ©2005 McGraw-Hill Ryerson Ltd.21 Microeconomics, Chapter 7 Short-run and Long-run Short RunShort Run –Fixed Plant Long RunLong Run –Variable Plant

22 ©2005 McGraw-Hill Ryerson Ltd.22 Microeconomics, Chapter 7 Chapter 7 Topics 7.1 The Firm & the Business Sector 7.2 Economic Costs 7.3 Short-run Production Relationships 7.4 Short-run Production Costs 7.5 Long-run Production Costs

23 ©2005 McGraw-Hill Ryerson Ltd.23 Microeconomics, Chapter 7 Total ProductTotal Product –total quantity produced Marginal ProductMarginal Product Average ProductAverage Product change in total product change in labour input = total product units of labour = Short-run Production Relationships

24 ©2005 McGraw-Hill Ryerson Ltd.24 Microeconomics, Chapter 7 Law of Diminishing Returns marginal product eventually diminishesmarginal product eventually diminishes Short-run Production Relationships

25 ©2005 McGraw-Hill Ryerson Ltd.25 Microeconomics, Chapter 7 units of labour TPMPAP00 110 225 345 460 570 675 775 870 change in total product change in labour input MP= Table 7-1

26 ©2005 McGraw-Hill Ryerson Ltd.26 Microeconomics, Chapter 7 units of labour TPMPAP00 110 225 345 460 570 675 775 870 10 15 20 15 10 5 0 -5 increasing marginal returns diminishing marginal returns negative marginal returns Table 7-1

27 ©2005 McGraw-Hill Ryerson Ltd.27 Microeconomics, Chapter 7 units of labour TPMPAP00 110 225 345 460 570 675 775 870 10 15 20 15 10 5 0 -5 10.00 12.50 15.0015.0014.00 12.50 10.71 8.75 Table 7-1 total product total labour input AP=

28 ©2005 McGraw-Hill Ryerson Ltd.28 Microeconomics, Chapter 7 AP MP TP increasing marginal returns diminishing marginal returns negative marginal returns Figure 7-2

29 ©2005 McGraw-Hill Ryerson Ltd.29 Microeconomics, Chapter 7 Marginal & Average Values if the average value is rising, the marginal value must be ABOVE the average valueif the average value is rising, the marginal value must be ABOVE the average value if the average value is falling, the marginal value must be BELOW the average valueif the average value is falling, the marginal value must be BELOW the average value

30 ©2005 McGraw-Hill Ryerson Ltd.30 Microeconomics, Chapter 7 Marginal & Average Values AP MP MP>APMP>AP MP<APMP<AP average value rising average value falling

31 ©2005 McGraw-Hill Ryerson Ltd.31 Microeconomics, Chapter 7 Chapter 7 Topics 7.1 The Firm & the Business Sector 7.2 Economic Costs 7.3 Short-run Production Relationships 7.4 Short-run Production Costs 7.5 Long-run Production Costs

32 ©2005 McGraw-Hill Ryerson Ltd.32 Microeconomics, Chapter 7 Fixed, Variable, & Total Costs Fixed CostsFixed Costs –do not vary with changes in output Variable CostsVariable Costs –change with changes in output Total CostTotal Cost –sum of fixed & variable cost

33 ©2005 McGraw-Hill Ryerson Ltd.33 Microeconomics, Chapter 7 Per-Unit, or Average Costs

34 ©2005 McGraw-Hill Ryerson Ltd.34 Microeconomics, Chapter 7 Marginal Cost Marginal cost is the extra, or additional cost of producing one more unit of outputMarginal cost is the extra, or additional cost of producing one more unit of output

35 ©2005 McGraw-Hill Ryerson Ltd.35 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC0100 1 2 3 4 5 6 7 8 9 10

36 ©2005 McGraw-Hill Ryerson Ltd.36 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC0100 1100 2100 3100 4100 5100 6100 7100 8100 9100 10100

37 ©2005 McGraw-Hill Ryerson Ltd.37 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC01000 110090 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930

38 ©2005 McGraw-Hill Ryerson Ltd.38 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC01000 110090 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930 100 190 270340400 470 550 640 750 880 1030 TC=TFC + TVC

39 ©2005 McGraw-Hill Ryerson Ltd.39 Microeconomics, Chapter 7 TFC

40 ©2005 McGraw-Hill Ryerson Ltd.40 Microeconomics, Chapter 7 TFC TVC add vertically to get TC

41 ©2005 McGraw-Hill Ryerson Ltd.41 Microeconomics, Chapter 7 TFC TVC TC

42 ©2005 McGraw-Hill Ryerson Ltd.42 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC01000 110090 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930 100 190 270340400 470 550 640 750 880 1030 100 50 33.332520 16.67 14.29 12.50 11.11 10 AFC=TFC / Q

43 ©2005 McGraw-Hill Ryerson Ltd.43 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC01000 110090 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930 100 190 270340400 470 550 640 750 880 1030 100 50 33.332520 16.67 14.29 12.50 11.11 10 90 85 807574 75 77.14 81.25 86.67 93 AVC=TVC / Q

44 ©2005 McGraw-Hill Ryerson Ltd.44 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC01000 110090 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930 100 190 270340400 470 550 640 750 880 1030 100 50 33.332520 16.67 14.29 12.50 11.11 10 90 85 807574 75 77.14 81.25 86.67 93 190 135 113.3310094 91.67 91.43 93.75 97.78 103 ATC=TC / Q

45 ©2005 McGraw-Hill Ryerson Ltd.45 Microeconomics, Chapter 7QTFCTVCTCAFCAVCATCMC01000 110090 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930 100 190 270340400 470 550 640 750 880 1030 100 50 33.332520 16.67 14.29 12.50 11.11 10 90 85 807574 75 77.14 81.25 86.67 93 190 135 113.3310094 91.67 91.43 93.75 97.78 103 90 80 70 60 70 80 90 110 130 150 MC=  TC /  Q Note: MC is graphed at average Q 2.5

46 ©2005 McGraw-Hill Ryerson Ltd.46 Microeconomics, Chapter 7 AFC AFC continually declines as fixed cost is spread over more & more units

47 ©2005 McGraw-Hill Ryerson Ltd.47 Microeconomics, Chapter 7 AFC AVC AVC is U-shaped: AVC starts to rise when AP starts to fall

48 ©2005 McGraw-Hill Ryerson Ltd.48 Microeconomics, Chapter 7 AFC AVC get ATC by vertically summing AFC & AVC

49 ©2005 McGraw-Hill Ryerson Ltd.49 Microeconomics, Chapter 7 AFC ATC AVC

50 ©2005 McGraw-Hill Ryerson Ltd.50 Microeconomics, Chapter 7 AFC ATC MC AVC MC cuts ATC & AVC at minimum points

51 ©2005 McGraw-Hill Ryerson Ltd.51 Microeconomics, Chapter 7 Labour Costs (dollars) Average Product and Marginal Product Output Productivity & Cost Curve Relationship, Figure 7-6

52 ©2005 McGraw-Hill Ryerson Ltd.52 Microeconomics, Chapter 7 Labour Average Product and Marginal Product Output Productivity & Cost Curve Relationship, Figure 7-6 MPMC Costs (dollars)

53 ©2005 McGraw-Hill Ryerson Ltd.53 Microeconomics, Chapter 7 Labour Costs (dollars) Average Product and Marginal Product Output Productivity & Cost Curve Relationship, Figure 7-6 MP AP MCAVC

54 ©2005 McGraw-Hill Ryerson Ltd.54 Microeconomics, Chapter 7 Relation of MC to AVC & ATC when MC < current ATCwhen MC < current ATC ðATC will fall when MC > current ATCwhen MC > current ATC ðATC will rise ðMC intersects ATC & AVC at minimum points

55 ©2005 McGraw-Hill Ryerson Ltd.55 Microeconomics, Chapter 7 Shifts of Cost Curves Factor Prices price of fixed input increases...price of fixed input increases... AFC & ATC shift upAFC & ATC shift up AVC & MC unchangedAVC & MC unchanged

56 ©2005 McGraw-Hill Ryerson Ltd.56 Microeconomics, Chapter 7 AFC ATC MC AVC

57 ©2005 McGraw-Hill Ryerson Ltd.57 Microeconomics, Chapter 7 AFC ATC MC AVC Fixed costs increase by $25

58 ©2005 McGraw-Hill Ryerson Ltd.58 Microeconomics, Chapter 7 Factor Prices price of variable input increases...price of variable input increases... ðAVC, ATC & MC shift up AFC unchangedAFC unchanged Shifts of Cost Curves

59 ©2005 McGraw-Hill Ryerson Ltd.59 Microeconomics, Chapter 7 AFC ATC MC AVC

60 ©2005 McGraw-Hill Ryerson Ltd.60 Microeconomics, Chapter 7 AFC ATC MC AVC Variable costs increase by 15%

61 ©2005 McGraw-Hill Ryerson Ltd.61 Microeconomics, Chapter 7 Technology improved technologyimproved technology ðlower costs ðcost curves shift down curve shifts depend on whether technology affects FC, VC or bothcurve shifts depend on whether technology affects FC, VC or both Shifts of Cost Curves

62 ©2005 McGraw-Hill Ryerson Ltd.62 Microeconomics, Chapter 7 Chapter 7 Topics 7.1 The Firm & the Business Sector 7.2 Economic Costs 7.3 Short-run Production Relationships 7.4 Short-run Production Costs 7.5 Long-run Production Costs

63 ©2005 McGraw-Hill Ryerson Ltd.63 Microeconomics, Chapter 7 Long-run Production Costs What will costs look like when the firm can choose the best plant size for any given situation?What will costs look like when the firm can choose the best plant size for any given situation?

64 ©2005 McGraw-Hill Ryerson Ltd.64 Microeconomics, Chapter 7 For every plant capacity size, there is a short-run ATC curveFor every plant capacity size, there is a short-run ATC curve All such plant capacities can be plotted....All such plant capacities can be plotted.... Firm Size & Costs

65 ©2005 McGraw-Hill Ryerson Ltd.65 Microeconomics, Chapter 7 ATC-1ATC-2 ATC-3 ATC-4 ATC-5 choose the best plant for every output level Firm Size & Costs

66 ©2005 McGraw-Hill Ryerson Ltd.66 Microeconomics, Chapter 7 ATC-1ATC-2 ATC-3 ATC-4 ATC-5 Firm Size & Costs

67 ©2005 McGraw-Hill Ryerson Ltd.67 Microeconomics, Chapter 7 these choices determine the LRATC curve LRATC The Long-run Cost Curve

68 ©2005 McGraw-Hill Ryerson Ltd.68 Microeconomics, Chapter 7 the number of possible plant sizes is virtually unlimited the number of possible plant sizes is virtually unlimited The Long-run Cost Curve

69 ©2005 McGraw-Hill Ryerson Ltd.69 Microeconomics, Chapter 7 the LR ATC curve just envelops the short-run cost curves the LR ATC curve just envelops the short-run cost curves LRATC The Long-run Cost Curve

70 ©2005 McGraw-Hill Ryerson Ltd.70 Microeconomics, Chapter 7 LRATC The Long-run Cost Curve

71 ©2005 McGraw-Hill Ryerson Ltd.71 Microeconomics, Chapter 7 Economies of scale LRATC Economies & Diseconomies of Scale

72 ©2005 McGraw-Hill Ryerson Ltd.72 Microeconomics, Chapter 7 Economies of scale Constant returns to scale LRATC Economies & Diseconomies of Scale

73 ©2005 McGraw-Hill Ryerson Ltd.73 Microeconomics, Chapter 7 Economies of scale Constant returns to scale Diseconomies of scale LRATC Economies & Diseconomies of Scale

74 ©2005 McGraw-Hill Ryerson Ltd.74 Microeconomics, Chapter 7 Economies of Scale –Labour specialization –Managerial specialization –Efficient capital –Other factors Diseconomies of ScaleDiseconomies of Scale Constant Returns to ScaleConstant Returns to Scale

75 ©2005 McGraw-Hill Ryerson Ltd.75 Microeconomics, Chapter 7 Applications & Illustrations successful startup firmssuccessful startup firms

76 ©2005 McGraw-Hill Ryerson Ltd.76 Microeconomics, Chapter 7 Applications & Illustrations successful startup firmssuccessful startup firms the daily newspaperthe daily newspaper

77 ©2005 McGraw-Hill Ryerson Ltd.77 Microeconomics, Chapter 7 Applications & Illustrations successful startup firmssuccessful startup firms the daily newspaperthe daily newspaper General MotorsGeneral Motors

78 ©2005 McGraw-Hill Ryerson Ltd.78 Microeconomics, Chapter 7 Minimum Efficient Scale ATC-1ATC-2 ATC-3 ATC-4 ATC-5 MES is the smallest level of output that minimizes LRATC

79 ©2005 McGraw-Hill Ryerson Ltd.79 Microeconomics, Chapter 7 Minimum Efficient Scale LRATC relatively large MES relatively large MES ðnatural monopoly relatively large MES relatively large MES ðnatural monopoly MESMES

80 ©2005 McGraw-Hill Ryerson Ltd.80 Microeconomics, Chapter 7 Minimum Efficient Scale MESMES LRATC relatively small MES relatively small MES ðcompetitive industry relatively small MES relatively small MES ðcompetitive industry

81 ©2005 McGraw-Hill Ryerson Ltd.81 Microeconomics, Chapter 7 Chapter 7 Topics 7.1 The Firm & the Business Sector 7.2 Economic Costs 7.3 Short-run Production Relationships 7.4 Short-run Production Costs 7.5 Long-run Production Costs

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