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The Costs of Production

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Step #1: Neatly PRINT left column names of students on a pink or yellow post-it ... Roach, John Russell, Mike. Sampson, Kristy Stang, David. Titzel, John Zador, John ... – PowerPoint PPT presentation

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Title: The Costs of Production


1
Chapter 13
  • The Costs of Production

2
Production 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

3
NAMES 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

4
Group Participants
  • Group 1 One Person
  • Group 2 Two Persons
  • Group 3 Three Persons
  • Group 4 Four Persons
  • ON CORE!!!!!!
  • Group 1 Five Persons

5
Chapter 13 Outline
  • Economic Profit
  • Diminishing Marginal Returns
  • Short Run Costs Table
  • Short Run Costs Graph
  • Long Run Costs Returns to Scale

Control Those Costs!
6
The Costs of Production
  • The Law of Supply
  • Firms produce more when price high.
  • Supply slopes upward.

Supply
7
Study Firm Behavior to
  • understand producer decisions.
  • Impact of market structure.

8
Goal 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

10
Costs of Production
  • Explicit Costs
  • Implicit Costs

11
Costs as Opportunity Costs
  • Firms costs include
  • Explicit Costs money outlay for resources
  • Implicit Costs Not direct outlay. (e.g.
    opportunity costs)

12
Costs 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.

13
Costs 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

14
Quick 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?

15
Economic 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

16
Economic 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

17
Producer Surplus Graphical
S
Producer Surplus
PE
Production Costs
D
QE
18
Diminishing 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

19
Short-Run Costs
  • Fixed Costs
  • Do not vary with output
  • Rent, licenses, certain taxes
  • Variable Costs
  • Vary with output
  • Labor, Raw Materials

20
Fixed 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.

21
Total 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

22
Marginal 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


23
Marginal 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

24
Average 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
25
Total 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

26
Average 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

27
Family of Total Costs...
  • Total Fixed Costs (TFC)
  • Total Variable Costs (TVC)
  • Total Costs (TC)
  • TC TFC TVC

28
Average 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

29
Average 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

30
Relationship 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

31
Marginal 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

32
Mathematical Definitions of Costs
  • Average Total Cost
  • ATC TC Q
  • Marginal Cost
  • MC TC Q

33
Quick 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?

34
The 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
36
Average 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
38
Average 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
40
Average 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
44
Total 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
53
The Shape of Typical Cost Curves
MC
ATC
Cost (s)
Quantity
54
The Shape of Typical Cost Curves
MC
ATC
Cost (s)
AVC
Quantity
55
The Shape of Typical Cost Curves
MC
ATC
Cost (s)
AVC
AFC
Quantity
56
Long-Run Average Cost Curve
Oh Great one more cost curve we have to
cover.study
In the long-run ALL resources are variable
57
ATC For 3 Firms

ATCsmall
0 1 2 3 4 5 6 7
Quantity
58
LRATC For 3 Firms

ATCsmall
ATCmedium
0 1 2 3 4 5 6 7
Quantity
59
LRATC For 3 Firms

ATCsmall
ATCmedium
ATC huge
0 1 2 3 4 5 6 7
Quantity
60
LRATC For 3 Firms

ATCsmall
ATCmedium
ATC huge
0 1 2 3 4 5 6 7
Quantity
61
LRATC For 3 Firms
LRATC

ATCs
ATCm
ATC h
0 1 2 3 4 5 6 7
Quantity
62
LRAC When Many Factory Sizes

LRATC
Efficient Scale
0 1 2 3 4 5 6 7
Quantity
63
LRAC When Many Factory Sizes

LRATC
0 1 2 3 4 5 6 7
Quantity
64
LRAC When Many Factory Sizes

Economices of Scale
LRATC
Efficient Scale
Diseconomices of Scale
0 1 2 3 4 5 6 7
Quantity
65
LRAC Natural Monopoly

LRAC
0 1 2 3 4 5 6 7
Quantity
66
Long-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

67
LRAC Efficient Scale Over Range

LRAC
Minimum Efficient Scale
A
15 10
0 1 2 3 4 5 6 7
Quantity
68
Economies 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

69
LRAC Efficient Scale Over Range

LRAC
Minimum Efficient Scale
A
15 10
B
0 1 2 3 4 5 6 7
Quantity
70
LRATC
LRATC TC/Q
71
LRTC 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

72
LRAC Efficient Scale Over Range

LRAC
Minimum Efficient Scale
0 1 2 3 4 5 6 7
Quantity
73
CHAPTER 13 ENDED
That wasn't too bad!
It's Competitive !
Great!
What's CH 14 LIKE??????
74
The 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.

75
The Relationship Between Marginal Cost and
Average Total Cost
  • The marginal-cost curve crosses the
    average-total-cost at the efficient scale.
  • Why?

76
Conclusion
  • 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.)

77
The 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
78
LRAC When 3 Factory Sizes

ATCm
ATCs
ATCl
LRATC
0 1 2 3 4 5 6 7
Quantity
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