A%20firm

1
EXPLICIT COSTS

• A firms actual cash payments for its inputs
• IMPLICIT COSTS
• Opportunity costs of non-purchased inputs such as
  the entrepreneurs time and money.
• opportunity cost of something is what you
  sacrifice to get it.
• Opportunity cost of the entrepreneurs time
• Time given up to operate a firm
• Opportunity cost of funds
• Money given up to set up and run a
  business.

2
Economic Cost

• The sum of explicit and implicit costs.
• The economic cost is higher because the economist
  includes implicit costs but the accountant does
  not.

3
Accounting versus Economic Cost
Accounting Economic Approach Approach
Explicit Cost (Purchased Inputs) 60,000 60,000
Implicit Cost (Opportunity cost of
30,000 entrepreneur) (Opportunity cost
of 10,000 funds) ------------- ---------
---- Total Cost 60,000 100,000
4
TIME PERIODS

• SHORT RUN
• A period of time over which at least one
  input to production is fixed. For most firms,
  the fixed input is capital firm cannot modify
  production facility or build a new facility.
• LONG RUN
• A period of time over which a firm is
  perfectly flexible in its choice of inputs.
• In the long run, a firm can build a new
  production facility (factory,store, office or
  restaurant) or modify an existing facility, hire
  a workforce, and buy raw materials.

5
Time Period Decisions

• Short Run
• How much output to produce
• Long Run
• What type of production facility to build

6
Principle of Diminishing Returns

• Suppose an output is produced with two or more
  inputs, and we increase one input while holding
  the other inputs fixed. Beyond some point --
  called the point of diminishing returns -- output
  will increase at a decreasing rate.

7
Computer Chip Manufacturing

• As firm packs more and more workers into factory,
  total output increases, but at a decreasing rate.
• ------------flipping this around-------------
• As the firm steadily increases its output, the
  firm requires more and more workers to increase
  its output by a single chip.

8
Diminishing Returns and Increasing Marginal Cost

• For One More
  Chip Quantity of Additional Additional
  Additional Marginal Chips Labor Time Labor
  Cost Material Cost Cost
• Small 100 2 hours 16 10 26
• Medium 300 6 hours 48 10 58
• Large 400 10hours 80 10 90

9
Short-Run Marginal Cost

• The change in total cost resulting from a
  one-unit increase in the output of an existing
  production facility.

10
Short-Run Marginal and Average Cost Curves
short-run average total cost curve (SATC)
short-run marginal cost curve (SMC)
Marginal or Average Cost
t
90
e
f
68
QUANTITY SMC SATC 100 26 90
300 58 58 400 90 68
58
m
26
s
100
300
400
Quantity of Chips produced per hour
11
Short-Run Average Total Cost (SATC)

• Equals the total cost divided by the quantity of
  output, or the cost per unit output.
• Total cost is the sum of the fixed cost per chip,
  the labor cost per chip, and the material cost
  per chip.
• U-shaped.

12
Short-Run Average Total Cost

• QUANTITY OF CHIPS
• SMALL MEDIUM LARGE
• Number of Chips 100 300 400
• Fixed Cost / Chip() 72 24 18
• Labor Hours 100 900 2,000
• Labor Cost () 800 7,200 16,000
• Labor Cost / Chip () 8 24 40
• Material Cost / Chip () 10 10 10
• Total Cost / Chip () 90 58 68

13
Short-Run Average Total Cost
QUANTITY OF CHIPS SMALL
MEDIUM LARGE Number of Chips 100
300 400 Fixed Cost () 7,200
7,200 7,200 Fixed Cost / Chip() 72
24 18 Labor Hours 100
900 2,000 Labor Cost () 800
7,200 16,000 Labor Cost / Chip () 8
24 40 Material Cost () 1,000
3,000 4,000 Material Cost / Chip () 10
10 10 Total Cost () 9,000 17,400
27,200 Total Cost / Chip () 90
58 68
14
Average Costs

• As production increases
• Fixed cost per chip decreases from
  72 to 24 to 18
• Labor cost per chip increases from
  8 to 24 to 40
• Material cost per chip doesnt
  change 10.
• Cost is lowest (58) at the medium level of
  production.

15
Marginal Average-Total Cost Relationship

• Short-run average total cost is at its minimum
  value where average total cost and marginal cost
  are equal. Average total cost slope 0.
• If marginal cost is less than average total cost,
  average total cost is decreasing -- has a
  negative slope.
• If marginal cost is greater than average total
  cost, average total cost is increasing -- has a
  positive slope.

16
SHORT-RUN AVERAGE COST CURVES
Short-run average variable cost (SAVC)
Short-run average total cost (SATC)
Average cost per chip ()
t
90
f
72
u
68
m
58
g
50
Quantity SATC SAVC AFC 100 90 18 72 300
58 34 24 400 68 50 18
n
34
h
24
v
p
Average Fixed Cost
18
100
300
400
Quantity of Chips per Hour
SATC SAVC AFC
17
LONG-RUN AVERAGE COST

• Total cost divided by the quantity of output when
  the firm can choose a production facility of any
  size
• The long-run average cost curve is L-shaped,
  initially the result of economies of scale.

18
Economies of Scale

• Cost saving associated with scaling up --
  adding more capital, labor and materials to
  produce more output may be caused by either of
  two effects
• Indivisible inputs
• Specialization

19
LONG-RUN AVERAGE COST CURVE FOR ALUMINUM
PRODUCTION
Average cost per pound
Long-run average cost curve
f
2.80
e
2.10
d
c
b
1.60
1.00
0.50
1.00
1.50
2.00
2.50
Millions of Pounds of Aluminum per year
20
Indivisible Inputs

• Inputs which cannot be scaled down to produce
  a small quantity of output.
  Examples
• Railroad track between two cities cannot be
  scaled from two to one track.
• An industrial mold must be complete to produce
  many copies or a single copy.

21
Specialization

• In a small operation with just a few workers,
  each performs a wide variety of tasks.
• In a large operation with many workers, each
  worker specializes in one or two tasks, and is
  more productive because
• Repetition increases productivity
• Workers spend less time switching from
  task to task.

22
Minimum Efficient Scale

• The output at which the long-run average cost
  curve becomes horizontal.

23
INDUSTRIES EXPERIENCING MINIMUM EFFICIENT SCALE
INDUSTRY MINIMUM EFFICIENT SCALE British
Sulfuric Acid 1 million tons British Steel
9 million tons U.S. Automobiles
200,000 to 400,000 per year Large U.S.
Breweries 4.5 million barrels
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DISECONOMIES OF SCALE

• Increase in output leads to increases in the
  average cost of production higher costs
  accompany scaling up.
• Diseconomies may occur for two reasons
• Coordination problems
• Increasing input costs.

25
Coordination Problems

• Large organizations require several layers of
  management (a bureaucracy) to coordinate the
  activities of the different parts of the
  organization. This leads to a positively sloped
  average-cost curve.

26
Increasing Input Costs

• As a firm increases its output, it will demand
  more of each of its inputs, which may lead to
  higher prices for some inputs.
• Higher prices increases the average cost of
  production, resulting in a positively sloped
  average-cost curve.

27
FOUR TYPES OF MARKETS

• Perfect Competition ---
• A market with a very large number of firms,
  each of which produces the same standardized
  product and takes the market price as given.
• A price-taking firm.

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FOUR TYPES OF MARKETS

• Perfect Competition
• EXAMPLES
• The wheat farmer,
• The average stock investor

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FOUR TYPES OF MARKETS

• Monopolistic Competition ---
• There are many firms, each sells a
  differentiated product. Because products sold by
  different firms are not perfect substitutes, each
  firm has some control over price. There are no
  barriers to entering the market.

30
FOUR TYPES OF MARKETS

• Monopolistic competition ---
• EXAMPLES
• restaurants,
• retail stores,
• gas stations,
• clothing

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FOUR TYPES OF MARKETS

• Oligopoly --- There are just a few firms in the
  market, a result of two sorts of barriers to
  entry
• economies of scale,
• government may limit number of firms
  in the market

32
FOUR TYPES OF MARKETS

• Oligopoly
• EXAMPLES
• automobiles,
• airline travel,
• breakfast cereals

33
FOUR TYPES OF MARKETS

• Monopoly ---
• A single firm serves the entire market. A
  monopoly occurs when the barriers to entry are
  very strong, which could result from very large
  economies of scale or a government limit on the
  number of firms.

34
FOUR TYPES OF MARKETS

• Monopoly ---
• EXAMPLES
• large scale economies
• local phone service,
• electric power generation,
• established by government policy
• drugs covered by patents,
• concessions in National Parks

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Characteristics of Different Types of Markets

• Perfect Monopolistic Oligopo
  ly Monopoly Competition Competition
• Number very large many
  few one

of firms Type of standardized
differentiated std or diff. unique
product Control none
slight considerable considerable
over price if not
regulated Entry no barriers
no barriers large large
conditions barriers barriers Examples
wheat restaurants automobiles local phone
soybeans retail stores air
travel and electric
clothing breakfast patented
cereal drugs
36
TOTAL REVENUE

• The money the firm gets from selling its product
  and is equal to price times quantity sold
• Total Revenue price quantity

37
ECONOMIC PROFIT

• Total revenue - total economic cost
• Total economic cost
• explicit costs
• ( firms actual cash payments for inputs )
• implicit costs
• ( opportunity costs of non-purchased inputs,
  such as entrepreneurs time or money )