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The Costs of
Production
8-2
Economic Costs
Equal to opportunity costs
Explicit + implicit costs
Explicit costs
Monetary payments
Implicit costs
Value of next best use
Self-owned resources
Self-employed resources
8-3
Profit
Accounting profit
Total revenue less explicit cost
Normal profit
Equal to implicit cost
Economic or pure profit
Total revenue less economic cost
8-4
Profits Compared
Economic Accounting
Economic
Profit Accounting
Total Revenue
Implicit Costs Profit
(Opportunity)
(Including a
Economic
Normal Profit)
Costs
Accounting
Explicit
Costs (Explicit
Costs Costs Only)
8-5
Short and Long Run
The short run
Fixed plant capacity
Variable intensity of plant use
Variable output
The long run
Variable plant capacity
Firms enter and exit
8-6
Production Relationships
Total product (TP)
Marginal product (MP)
Total Product
Average Product = Units of Labor
8-7
Law of Diminishing Returns
Fixed technology
Add variable resource to fixed
resource
Marginal product will decline
Beyond some point
Rationale
8-8
Law of Diminishing Returns
(3) (3)
(1) Marginal Product Average
Units of the (2) (MP), Product
Variable Resource Total Product Change in (2)/ (AP),
(Labor) (TP) Change in (1) (2)/(1)
0 0 -
1 10
] 10 Increasing 10.00
2 25
] 15 Marginal
12.50
Returns
3 45
] 20
15.00
4 60
] 15
Diminishing 15.00
5 70
] 10 Marginal 14.00
6 75
] 5 Returns
12.50
75
] 0 Negative
10.71
7
] -5 Marginal
8.75
8 70 Returns
8-9
Law of Diminishing Returns
Total Product, TP
30
TP
20
10
0
1 2 3 4 5 6 7 8 9
Marginal Product, MP
10 AP
1 2 3 4 5 6 7 8 9
MP
8-10
Short-Run Production Costs
Fixed Costs
Do not vary with output
Variable Costs
Materials, most labor
Total Cost
TC = TFC + TVC
8-11
Per-Unit Production Costs
600
Costs
Fixed
500 Cost
400
300 Total Variable
Cost Cost
200
100
TFC
0 1 2 3 4 5 6 7 8 9 10 Q
8-13
Short-Run Production Costs
$200
MC
150
ATC
Costs
100
AVC
AFC
50
AVC
AFC
0 1 2 3 4 5 6 7 8 9 10 Q
8-14
Production Relationships
Marginal cost and diminishing returns
Marginal cost and marginal product
Marginal cost and average variable
cost
Marginal cost and average total cost
Production curves and cost curves
Shifts in cost curves
8-15
Graphical Relationships
Production Curves
AP
MP
Quantity of Labor
MC
AVC
Cost (Dollars)
Cost Curves
Quantity of Output
8-16
Long-Run Production Costs
Choose your plant size
Minimize ATC
Different ATC curves
Short run
Long run ATC
Envelope of short run ATC
8-17
Long-Run ATC Curve
Output
Output
8-20
Long-Run ATC Shapes
Economies Constant Returns Diseconomies
Average Total Costs Of Scale To Scale Of Scale
Long-Run
ATC
q1 q2
Output
Long-Run
ATC
Output
Long-run ATC curve where costs are
lowest only when large numbers are
participating
8-22
Long-Run ATC Shapes
Economies Diseconomies
Average Total Costs Of Scale Of Scale
Long-Run
ATC
Output
Long-run ATC curve where economies
of scale exist, are exhausted quickly,
and turn back up substantially
8-23
Industry Structure
Minimum efficient scale (MES)
Natural monopoly
Applications and illustrations
Price of corn
Successful start-up firms
The Verson stamping machine
The daily newspaper
Aircraft and concrete plants
8-24
Sunk Costs
Irrelevant in decision making
Cannot be recovered
Do not affect marginal
benefit and marginal cost
Firm example:
R&D costs
8-25
Key Terms
economic (opportunity) variable costs
cost total cost
explicit costs average fixed cost (AFC)
implicit costs average variable cost (AVC)
normal profit average total cost (ATC)
economic profit marginal cost (MC)
short run economies of scale
long run diseconomies of scale
total product (TP) constant returns to scale
marginal product (MP) minimum efficient scale
average product (AP) (MES)
law of diminishing returns natural monopoly
fixed costs
8-26