1. Microeconomics ECON 2302 May 2009 Marilyn Spencer, Ph.D. Professor of Economics Chapter 10

2. Reviewing Learning Objectives from Chapter 8. You should be able to: 4Discuss the increasing importance of international trade to the United States. 4 Understand the difference between comparative advantage and absolute advantage. 4Explain how countries gain from international trade. 4Discuss the sources of comparative advantage. 4Analyze the economic effects of government policies that restrict international trade. 4Evaluate the arguments for and against government policies that restrict international trade.

3. Any questions on these topics? Anything else?

4. Chapter 10. Technology, Production & Costs

5. Sony Uses a Cost Curve to Determine the Price of Radios

6. 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. 1 2 3 4 5 6 LEARNING OBJECTIVES In this chapter, we will focus on the relationship between a firm’s technology and its production costs.

7. Technology: An Economic Definition LEARNING OBJECTIVE 1 4 Technology The processes a firm uses to turn inputs into outputs of goods and services. 4 Technological change A change in the ability of a firm to produce a given level of output with a given quantity of inputs.

8. Improving Inventory Control at Wal-Mart 10 - 1 Better inventory controls have helped reduce firms’ costs.

9. The Short Run and the Long Run 4 Short run The period of time during which at least one of the firm’s inputs is fixed. 4 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

10. The Short Run and the Long Run: The Difference between Fixed Costs & Variable Costs 4 Total cost The cost of all the inputs a firm uses in production. 4 Variable costs Costs that change as output changes. 4 Fixed costs Costs that remain constant as output changes. Total Cost = Fixed Cost + Variable Cost TC = FC + VC

11. Fixed Costs in the Publishing Industry 10 - 2 COSTAMOUNT Salaries and Benefits Rent Utilities Supplies Postage Travel Subscriptions, etc. Miscellaneous Total $437,500 $75,000 $20,000 $6,000 $4,000 $8,000 $4,000 $5,000 $559,500 The salaries of editors are considered a fixed cost by publishers.

12. The Short Run and the Long Run: Implicit versus Explicit Costs 4 Opportunity cost The highest-valued alternative that must be given up to engage in an activity. 4 Explicit cost A cost that involves spending money. 4 Implicit cost A nonmonetary opportunity cost.

13. The Short Run and the Long Run Jill Johnson’s Costs per Year 10 – 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

14. The Production Function 4 Production Function The relationship between the inputs employed by the firm and the maximum output it can produce with those inputs.

15. 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 10 – 2 QUANTITY OF WORKERS QOF COPY MACHINESQ OF COPIES COST OF COPY MACHINES (FIXED COST) COST OF WORKERS (VARIABLE COST) TOTAL COST OF COPIE S 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

16. 4 Average total cost Total cost divided by the quantity of output produced.

17. The Short Run and the Long Run A First Look at the Relationship Between Production and Cost 10 - 1 Graphing Total cost and Average Total Cost at Jill Johnson’s Photocopy Store

18. The Marginal Product of Labor and the Average Product of Labor LEARNING OBJECTIVE 3 4 Marginal product of labor The additional output a firm produces as a result of hiring one more worker. The Law of Diminishing Returns 4 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.

19. 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 10 – 3

20. 10 - 2 Total Output and the Marginal Product of Labor The Marginal Product of Labor and the Average Product of Labor: Graphing Production

21. Adam Smith’s Famous Account of the Division of Labor in a Pin Factory 10 - 3 The gains from division of labor and specialization are as important to firms today as they were in the eighteenth century when Adam Smith first discussed them.

22. The Relationship between Marginal and Average Product 4 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:

23. An Example of Marginal and Average Values: College Grades 10 - 3 Marginal and Average GPAs The Marginal Product of Labor and the Average Product of Labor:

24. The Relationship Between Short-Run Production and Short-Run Cost LEARNING OBJECTIVE 4 Marginal Cost 4 Marginal Cost The change in a firm’s total cost from producing one more unit of a good or service.

25. Why Are the Marginal and Average Cost Curves U-Shaped? 10 - 4 Jill Johnson’s Marginal Cost and Average Cost of Producing Copies The Relationship Between Short-Run Production and Short-Run Cost:

26. The Relationship Between Marginal and Average Cost

27. Graphing Cost Curves 4 Average fixed cost Fixed cost divided by the quantity of output produced. 4 Average variable cost Variable cost divided by the quantity of units produced. 4 Average total cost = ATC = TC/Q 4 Average fixed cost = AFC = FC/Q 4 Average variable cost = AVC = VC/Q ATC = AFC + AVC LEARNING OBJECTIVE 5

28. Graphing Cost Curves 10 - 5 Costs at Jill Johnson’s Copy Store

29. Costs in the Long Run: LEARNING OBJECTIVE 6 Economies of Scale 4 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. 4 Economies of scale Economies of scale exist when a firm’s long-run average costs fall as it increases output.

30. Costs in the Long Run: Economies of Scale 4 Constant returns to scale Constant returns to scale exist when a firm’s long-run average costs remain unchanged as it increases output. 4 Minimum efficient scale The level of output at which all economies of scale have been exhausted. 4 Diseconomies of scale Exist when a firm’s long- run average costs rise as it increases output.

31. Costs in the Long Run: Long-Run Average Total Cost Curves for Bookstores 10 - 6 The Relationship Between: Short-Run Average Cost and Long-Run Average Cost

32. Using Long-Run Average Cost Curves to Understand Business Strategy 10-2 LEARNING OBJECTIVE 6

33. The Colossal River Rouge: Diseconomies of Scale at the Ford Motor Company 10 - 4 Is it possible for a factory to be too big?

34. Don’t Confuse Diminishing Returns with Diseconomies of Scale

35. Conclusion A Summary of Definitions of Cost 10 – 4 TERMDEFINITION SYMBOLS & 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-

36. It’s ‘Win-Win’ as Samsung, Sony Join on Flat Screens

37. 4 Average fixed cost 4 Average variable cost 4 Average product of labor 4 Average total cost 4 Constant returns to scale 4 Diseconomies of scale 4 Economies of scale 4 Explicit cost 4 Fixed costs 4 Implicit cost 4 Law of diminishing returns 4 Long run 4 Long-run average cost curve 4 Marginal cost 4 Marginal product of labor 4 Minimum efficient scale 4 Opportunity cost 4 Production function 4 Short run 4 Technological change 4 Technology 4 Total cost 4 Variable costs

38. Reality Check Assignment to for Chapter 11: 4 Study Ch. 11, and be able to answer ÜReview Questions: pg 404; 1.1, 1.2 & 1.3; pg 406; 3.2; pg 405; 2.2; pg 407; 4.1; pg 408; 5.1, 5.2 & 5.3; pg 409; 6.1; (1 st edition: 1 - 10 on pp. 380-381), Üand – on the following page…

39. Reality Check Assignment to for Ch. 11, continued: Problems and Applications: p. 404, 1.4; p. 406, 3.7; p. 407, 4.3; p. 408, 5.4 & 5.9; and this application: The following is an excerpt from a newspaper story on the state of the lettuce market in the spring of 2002: “The shortage [of lettuce] began with freezing weather that cut per- acre yields by more than half in parts of California, where more than half of the nation’s supply is grown. At the same time, many farmers grew less lettuce, fearing a drop in demand after Sept. 11 [2001] because many people dined out less. The result has been high prices. In some parts of the country, iceberg lettuce has topped $3 per head at grocery stores, up from the regular $1 to $2. Prices are expected to drop to their usual levels in the next two to three weeks as new supplies catch up to demand,” said Ashraf Zaki, a market price reporter for the Agriculture Department in Forest Park, Ga. Use a demand-and-supply graph to illustrate the changes in the lettuce market described in this story. Briefly explain any shifts of the demand and supply curves in your graph. Why was the market prices reporter for the Agriculture Department confident that prices would drop “to their usual levels”? (1 st edition: 1, 3, 7, 14, 20 & 21 on pp. 381-384).