Title: The Costs of Production
1Chapter 13
2Production Activity
- Activity
- Step 1 Neatly PRINT left column names of
students on a pink or yellow post-it and stick
it on left side of an index card - Step 2 Neatly PRINT right column names of
students on a blue or purple post-it and stick
it on right side of that same index card - GOAL To Complete as many cards as possible in
four minute period - NOTE For each card to count, each post-it must
contain all names in order as shown on next slide
3NAMES FOR POST ITS ACTIVITY
- Pink or Yellow Blue or Purple
- Boff, Angelo Conklin, Jacob
- Cosgrave, Will Dito, Chris
- Easton, Candace Gibson, Justin
- Goulet, Louie Guffey, Mike
- Hinsdale, Sarah Holley, Jamal
- Huth, Jenn Krughermellencamp, John
- Kacazy, Brandan Laurzenza, Vic
- Lynn, Kris McCabe, Justin
- Mennel, Ford Morgan, Greg
- Olsen, Brad Ott, Bruce
- Pohorence, Tim Pokoj, Seth
- Roach, John Russell, Mike
- Sampson, Kristy Stang, David
- Titzel, John Zador, John
4Group Participants
- Group 1 One Person
- Group 2 Two Persons
- Group 3 Three Persons
- Group 4 Four Persons
- ON CORE!!!!!!
- Group 1 Five Persons
5Chapter 13 Outline
- Economic Profit
- Diminishing Marginal Returns
- Short Run Costs Table
- Short Run Costs Graph
- Long Run Costs Returns to Scale
Control Those Costs!
6The Costs of Production
- The Law of Supply
- Firms produce more when price high.
- Supply slopes upward.
Supply
7Study Firm Behavior to
- understand producer decisions.
- Impact of market structure.
8Goal of Business Firm
- maximize profits!
- Profit Total Revenue - Total Cost.
9 Firms Profit TR - TC
- Total Revenue Price x Quantity (P x Q) .
- Total Costs Includes opportunity costs
- Profit related to
- Producer Surplus amount paid to seller less
production costs
10Costs of Production
- Explicit Costs
- Implicit Costs
11Costs as Opportunity Costs
- Firms costs include
- Explicit Costs money outlay for resources
- Implicit Costs Not direct outlay. (e.g.
opportunity costs)
12Costs as Opportunity Costs
- Economists include all opportunity costs when
measuring costs. - Accountants measure the explicit costs but often
ignore the implicit costs. - When revenues exceed both explicit and implicit
costs the firm earns economic profits.
13Costs as Opportunity Costs
- A third, not so obvious implicit cost includes
sunk costs. - Sunk costs are costs that have already been
committed and cannot be recovered. Sunk Costs
are . . . - an opportunity cost
- often ignored when making decisions about
business strategy
14Quick Quiz
- A farmer has planted corn seeds but has not yet
fertilized the field. - Is the cost of seed an opportunity cost or a sunk
cost? - Is the cost of fertilizer an opportunity cost or
a sunk cost? - Which of these two costs is more likely to affect
the decision to continue farming?
15Economic Profit
- Total Revenue 10.0 million
- - Explict Costs - 9.0 million
- workers, supplies etc
- Accounting Profit 1.0 million
- - Implicit Costs - 0.5 million
- Economic Profit 0.5 million
16Economic Profit
- Total Revenue 10.0 million
- - Explict Costs - 9.0 million
- workers, supplies etc
- Accounting Profit 1.0 million
- - Implicit Costs -7.0 million
- Economic Profit -6.0 million
17Producer Surplus Graphical
S
Producer Surplus
PE
Production Costs
D
QE
18Diminishing Marginal Returns (DMR)
- Law of DMR Additional units of
- variable Resource yield ever smaller increases in
output - Labor 0 1 2 3 4 5 6
- Output 0 10 40 50 55 57 58
- MP - 10 30 10 05 02 01
- MP Marginal Product of Labor
- Extra Output produced by additional worker
19Short-Run Costs
-
- Fixed Costs
- Do not vary with output
- Rent, licenses, certain taxes
- Variable Costs
- Vary with output
- Labor, Raw Materials
20Fixed versus Variable Costs
- Depends on time horizon
- Short Run some costs fixed (e.g. plant size.)
- Long-Run all costs variable. (i.e., planning
horizon) - More flexibility in L.R.
21Total Cost Family
- Q (Output) FC VC TC
- 0 100 0 100
- 1 100 20 120
- 2 100 30 130
- 3 100 50 150
- 4 100 80 180
- 5 100 120 220
- 6 100 170 270
- 7 100 230 330
22Marginal Cost (MC)
- MC Cost of Producing One More Unit t
- MC TC / Q
- When Output rises from 1 to 2
- MC (130 - 120) / (2 - 1) 10/1 10
23Marginal Cost (MC)
- Q TC MC
- 0 100 -
- 1 120 20
- 2 130 10
- 3 150 20 DMR
- 4 180 30
- 5 220 40
- 6 270 50
- 7 330 60
24Average Total Cost Family
- FC VC TC
- ----- ----- ------
- Q Q Q
- AFC AVC ATC
- Average Fixed Costs (AFC)
- Average Variable Costs (AVC)
- Average Total Costs (ATC)
Need Relief?
Turtles to the Rescue
25Total Cost Family
- Q (Output) FC VC TC
- 0 100 0 100
- 1 100 20 120
- 2 100 30 130
- 3 100 50 150
- 4 100 80 180
- 5 100 120 220
- 6 100 170 270
- 7 100 230 330
26Average Total Cost Family
- Q (Output) AFC AVC ATC
- 0 - - -
- 1 100 20 120
- 2 50 15 65
- 3 33 17 50
- 4 25 20 45
- 5 20 24 44
- 6 17 28 45
- 7 14 33 47
27Family of Total Costs...
- Total Fixed Costs (TFC)
- Total Variable Costs (TVC)
- Total Costs (TC)
- TC TFC TVC
28Average Total Cost Family
- Q AFC AVC ATC MC
- 0 - - - -
- 1 100 20 120 20
- 2 50 15 65 10
- 3 33 17 50 20
- 4 25 20 45 30
- 5 20 24 44 40
- 6 17 28 45 50
- 7 14 33 47 60
29Average Total Cost Family
- Q AFC AVC ATC MC
- 0 - - - -
- 1 100 20 120 20
- 2 50 15 65 10
- 3 33 17 50 20
- 4 25 20 45 30
- 5 20 24 44 40
- 6 17 28 45 50
- 7 14 33 47 60
30Relationship Between MC and ATC
- If MC less than ATC, ATC falling.
- MC lt ATC ATC
- If MC greater than ATC, ATC rising.
- MC gt ATC ATC
31Marginal Cost How much does it cost to produce
an additional unit of output?
- Marginal Cost (MC)
- The extra or additional cost of producing one
more unit of output. - MC is the addition to the cost of production that
must be covered by additional revenue for profit
maximization
32Mathematical Definitions of Costs
- Average Total Cost
- ATC TC Q
- Marginal Cost
- MC TC Q
33Quick Quiz!
- If Fords total cost of producing 4 cars is
225,000 and its total cost of producing 5 cars
is 250,000. . . - ...what is the average total cost and marginal
cost of producing the fifth car?
34The Shape of Typical Cost Curves
- Marginal Cost rises with output
- At low output levels , MC small.
- MC eventually rises due to DMR
- MC rises more sharply in short run.
Jackanapes! Think About that!
Refreshing A slide without gimmicks
Oh!
35 Shapes of Cost Curves
MC
Cost (s)
Quantity
36Average Total Cost Family
- Q AFC AVC ATC MC
- 0 - - - -
- 1 100 20 120 20
- 2 50 15 65 10
- 3 33 17 50 20
- 4 25 20 45 30
- 5 20 24 44 40
- 6 17 28 45 50
- 7 14 33 47 60
37 Shapes of Cost Curves
MC
40
10
0 1 2 3 4 5 6 7
Quantity
38Average Total Cost Family
- Q AFC AVC ATC MC
- 0 - - - -
- 1 100 20 120 20
- 2 50 15 65 10
- 3 33 17 50 20
- 4 25 20 45 30
- 5 20 24 44 40
- 6 17 28 45 50
- 7 14 33 47 60
39 Shapes of Cost Curves
MC
40
AVC
10
0 1 2 3 4 5 6 7
Quantity
40Average Total Cost Family
- Q AFC AVC ATC MC
- 0 - - - -
- 1 100 20 120 20
- 2 50 15 65 10
- 3 33 17 50 20
- 4 25 20 45 30
- 5 20 24 44 40
- 6 17 28 45 50
- 7 14 33 47 60
41 Shapes of Cost Curves
MC
ATC
40
AVC
10
0 1 2 3 4 5 6 7
Quantity
42 Shapes of Cost Curves
MC
ATC
44
AVC
AFC
24
0 1 2 3 4 5 6 7
Quantity
43 Shapes of Cost Curves
MC
ATC
44
AVC
AFC
24
10
0 1 2 3 4 5 6 7
Quantity
44Total Cost
- ATC TC/Q
- Multiply both sides by Q
- Q x ATC TC
- 5 x 44 220
- Length x Width Area
45 Shapes of Cost Curves
MC
ATC
44
AVC
Total Cost (TC) 5 x 44 220
AFC
24
0 1 2 3 4 5 6 7
Quantity
46 Shapes of Cost Curves
MC
ATC
44
AVC
24
10
0 1 2 3 4 5 6 7
Quantity
47 Shapes of Cost Curves
MC
ATC
44
AVC
Total Cost (TC) 5 x 44 220
24
10
0 1 2 3 4 5 6 7
Quantity
48 Shapes of Cost Curves
MC
ATC
44
AVC
AFC
24
Variable Cost (VC) 120
0 1 2 3 4 5 6 7
Quantity
49 Shapes of Cost Curves
MC
ATC
44
AVC
Fixed Cost (FC) 100
AFC
24
Variable Cost (VC) 120
0 1 2 3 4 5 6 7
Quantity
50 Shapes of Cost Curves
MC
ATC
44
AVC
Fixed Cost (FC)
AFC
24
Variable Cost (VC)
10
0 1 2 3 4 5 6 7
Quantity
51 Shapes of Cost Curves
MC
ATC
44
AVC
TC VC FC
24
10
0 1 2 3 4 5 6 7
Quantity
52 Shapes of Cost Curves
MC
ATC
44
AVC
24
10
0 1 2 3 4 5 6 7
Quantity
53The Shape of Typical Cost Curves
MC
ATC
Cost (s)
Quantity
54The Shape of Typical Cost Curves
MC
ATC
Cost (s)
AVC
Quantity
55The Shape of Typical Cost Curves
MC
ATC
Cost (s)
AVC
AFC
Quantity
56Long-Run Average Cost Curve
Oh Great one more cost curve we have to
cover.study
In the long-run ALL resources are variable
57ATC For 3 Firms
ATCsmall
0 1 2 3 4 5 6 7
Quantity
58LRATC For 3 Firms
ATCsmall
ATCmedium
0 1 2 3 4 5 6 7
Quantity
59LRATC For 3 Firms
ATCsmall
ATCmedium
ATC huge
0 1 2 3 4 5 6 7
Quantity
60LRATC For 3 Firms
ATCsmall
ATCmedium
ATC huge
0 1 2 3 4 5 6 7
Quantity
61LRATC For 3 Firms
LRATC
ATCs
ATCm
ATC h
0 1 2 3 4 5 6 7
Quantity
62LRAC When Many Factory Sizes
LRATC
Efficient Scale
0 1 2 3 4 5 6 7
Quantity
63LRAC When Many Factory Sizes
LRATC
0 1 2 3 4 5 6 7
Quantity
64LRAC When Many Factory Sizes
Economices of Scale
LRATC
Efficient Scale
Diseconomices of Scale
0 1 2 3 4 5 6 7
Quantity
65LRAC Natural Monopoly
LRAC
0 1 2 3 4 5 6 7
Quantity
66Long-Run Cost Curves
- U-Shaped Average Total Cost
- Economies of Scale occurs when a firm has large
fixed costs. - ATC declines as output increases
- Diseconomies of Scale occurs when some key input
is limited. - ATC rises as output increases
67LRAC Efficient Scale Over Range
LRAC
Minimum Efficient Scale
A
15 10
0 1 2 3 4 5 6 7
Quantity
68Economies of Scale
- At A
- K1, L 1, Q 1. If Pk10, wage 5
- TC 10(1) 5(1) 15
- LRATC TC/Q 15/1 15
- At B
- K2, L 2, Q 3.
- TC 10(2) 5(2) 30
- LRATC TC/Q 30/3 10
69LRAC Efficient Scale Over Range
LRAC
Minimum Efficient Scale
A
15 10
B
0 1 2 3 4 5 6 7
Quantity
70LRATC
LRATC TC/Q
71LRTC in 2 Industries
- Q LRTC LRAC
- 0 0 ---
- 1 10 10
- 2 20 10
- 4 40 10
- 8 80 10
- CONSTANT RETURNS TO SCALE
- LRAC horizontal
- Q LRTC LRAC
- 0 0 ---
- 1 10 10
- 2 16 8
- 4 24 6
- 5 25 5
- ECONOMIES OF SCALE
- LRAC FALLING
- Natural Monopoly
72LRAC Efficient Scale Over Range
LRAC
Minimum Efficient Scale
0 1 2 3 4 5 6 7
Quantity
73CHAPTER 13 ENDED
That wasn't too bad!
It's Competitive !
Great!
What's CH 14 LIKE??????
74The Shape of Typical Cost Curves
- U-Shaped Average Total Cost
- The bottom of the U-Shape occurs at the quantity
that minimizes average total cost - This is called the Efficient Size of the firm.
75The Relationship Between Marginal Cost and
Average Total Cost
- The marginal-cost curve crosses the
average-total-cost at the efficient scale. - Why?
76Conclusion
- When analyzing firm behavior, it is often useful
to graph average total cost and marginal cost. - For a typical firm, marginal cost rises with the
amount of output. - Average total cost first falls as output
increases (showing economies of scale) and then
rises as output increases further (showing
diseconomies of scale.)
77The Relationship Between Marginal Cost and
Average Total Cost
MC
ATC
Cost (s)
The marginal cost curve always crosses the
average total cost curve at the minimum average
total cost!
Quantity
78LRAC When 3 Factory Sizes
ATCm
ATCs
ATCl
LRATC
0 1 2 3 4 5 6 7
Quantity