Organize factors of production and/or

1
A firm is an economic institution that
transforms factors of production into goods and
services

1. Organize factors of production and/or
2. Produce goods and services and/or
3. Sell produced goods and services

• A virtual firm organizes production and
  subcontracts out all work

• Many of the organizational structures of business
  are being separated from the production process

2
Business
explicit
Costs
implicit (opportunity)
total
economic
Profits
normal
accounting
3
Production times
Long Run
The factory size can change
Short Run
Factors like labor and raw
materials can be changed
labor
raw materials

• Long run and short run do not necessarily refer
  to specific periods of time, but to the
  flexibility the firm has in changing the level of
  output

4
The Production Function
The recipe going from inputs to outputs
Efficient Production
The least cost combination of inputs.
It varies by firm
5
The Production Function Output
Data Output
Labor Total Marginal Average
0 0
___
3
___
3
1 3
___
5
___
4
2 8
___
4
___
4
3 12
___
3
3.75
___
4 15
2
___
___
3.4
5 17
___
1
___
3
6 18
6
The Production Function Output
Total Output
Output
18
15
12
9
6
3
0
1
2
3
4
5
6
Quantity of Labor
7
The Production Function Output
Average and Marginal
Output
6
5
4
3
2
1
0
1
2
3
4
5
6
Quantity of Labor
8
The Law of Diminishing Returns
In the beginning, output increases with each unit
added, but at some point output will begin to
decrease with each additional unit of a resource.
Like Labor
9
The Production Function Output
Data Output
Labor Total Marginal Average
0 0
___
3
___
3
1 3
Increasing marginal productivity
___
5
___
4
2 8
___
4
___
4
Diminishing marginal productivity
3 12
___
3
3.75
___
4 15
2
___
___
3.4
5 17
___
1
___
3
6 18
Diminishing Absolute productivity
10
Production Costs
Total Fixed Costs
rent
Do not change with output
bourbon scotch beer
Total Variable Costs
Do change with output
Total Costs TFC TVC
11
Unit Production Costs
Average Fixed Costs
Average Variable Costs
Average Total Costs ??
Marginal Cost
Change in cost with 1 more output
Do change with output
Do not change with output
12
A Problem
Marcia Deal
bakes and decorates large,
elaborate, multi-layered, special occasion cakes.
She produces these in her own home without any
help, unless she has a large number of orders on
a particular day.
13
The Problem
TC TFC TVC ATC MC
0
1
2
3
4
5
6
7
8
With the following information, complete the
table
The total cost of producing 5 cakes is 135
Marcias total fixed cost for 1 cake is 25
The marginal cost for the 8th cake is 91
The ATC per cake when 3 cakes or when 4 cakes are
made is 25
The total variable cost of producing 7 cakes is
220
The marginal cost of the 6th cake is 45
The total cost of 2 cakes is 60
The total variable cost for 1 cake is 25
Why is the Marginal Cost of the 7th and 8th cakes
fairly high?
14
If Marcia can sell from 0 - 8 cakes at 40 each,
how many will she choose to produce and sell per
day if she is trying to maximize her profits??
On the graph, plot the average total cost and
marginal cost of producing from 0 8 cakes.
Plot the marginal cost at the midpoints
15
Graph Marcias ATC, MC and MR
120 110 100 90 80 70 60 50 40 30 20 10 0












Average Total Cost and Marginal Cost
1 2 3 4
5 6 7 8
Number of Cakes
16
Graph Marcias ATC, MC and MR
120 110 100 90 80 70 60 50 40 30 20 10 0












Average Total Cost and Marginal Cost
1 2 3 4
5 6 7 8
Number of Cakes
17
Number of Cakes Total Revenue Total Cost Total Profit Marginal Revenue Marginal Cost
0
1
2
3
4
5
6
7
8
18
Graph Marcias TC, TFC and TVC
350 300 250 200 150 100 50 0














Total Cost
1 2 3 4
5 6 7 8
Number of Cakes
19
Graph Marcias TC, TFC and TVC
350 300 250 200 150 100 50 0














Total Cost
1 2 3 4
5 6 7 8
Number of Cakes
20
The Production Function
Output TFC TVC TC
0 100 0
100 150 190 220 260 320 400 500 620 770 1000
1 50
___
___
100 100 100 100 100 100 100 100 100 100
___
___
2 90
___
___
3 120
___
___
4 160
5 220
___
___
___
___
6 300
7 400
___
___
___
___
8 520
9 670
___
___
___
___
10 900
21
The Production Function Costs
Output AFC AVC ATC MC
50 40 30 40 60 80 100 120 150 230
0 (TFC/output) (TVC/output) (TC/output)
(TC1-TC0)
50 45 40 40 44 50 59 65 74 90
150 95 73 65 64 67 73 78 85 100
100 50 33 25 20 17 14 12 11 10
1 2 3 4 5 6 7 8 9 10
1 ________ ________ ________ _____
2 ____________ ____________ ____________
_______
3 ____________ ____________ ____________
_______
4 ____________ ____________ ____________
_______
5 ____________ ____________ ____________
_______
6 ____________ ____________ ____________
_______
7 ____________ ____________ ____________
_______
8 ____________ ____________ ____________
_______
9 ____________ ____________ ____________
_______
10 ____________ ____________ ____________
_______
22
Total Costs
900
Cost
800
700
600
Total Cost
500
400
Total Variable Cost
300
200
Total Fixed Cost
100
0
6
7
8
9
10
3
4
5
1
2
Output
23
90
80
Cost
70
ATC
60
50
and
40
MC
30
20
Graphed
AVC
10
AFC
0
6
7
8
9
10
3
4
5
1
2
Output
24

The Relationship Between Marginal Productivity
and Marginal Costs
Costs per unit
MC
AVC
If marginal productivity is rising, marginal
costs are falling
Q
If average productivity is falling, average costs
are rising
Output per worker
AP of workers
MP of workers
Q
12-24
25

The Relationship Between Marginal Cost and
Average Cost

• If MC gt ATC, then ATC is rising
• If MC gt AVC, then AVC is rising
• If MC lt ATC, then ATC is falling
• If MC lt AVC, then AVC is falling
• If MC AVC and MC ATC, then AVC and ATC are at
  their minimum points

12-25
26
The Relationship Between Marginal Cost and
Average Cost
Costs per unit
The marginal cost curve goes through the
minimum point of both the ATC and AVC curves
MC
ATC
AVC
Q
12-26
27
12 Questions
28

• Which of the following is most likely to be an
  implicit cost of production?
• property taxes on a building owned by the firm
• transportation costs paid to a trucking supplier
• c. rental payments for a building utilized by
  the company and rented from another party
• d. interest income foregone on funds invested in
  the firm by the owners

2. The law of diminishing returns a. explains why
marginal cost eventually increases as output
expands. b. implies that average fixed cost will
remain unchanged as output expands. c. is true
for physical production activities but not for
activities such as studying. d. applies to a
capitalist economy but would be irrelevant if the
means of production were owned by the state.
3. Which of the following represents a long-run
adjustment? a. the hiring of four additional
cashiers by a supermarket b. a cutback on
purchases of coke and iron ore by a steel
manufacturer c. construction of a new
assembly-line plant by a car manufacturer d. the
extra dose of fertilizer used by a farmer on his
wheat crop
29
4. The short-run average total cost (ATC) curve
of a firm is U-shaped because a. larger firms
always have lower per-unit costs than smaller
firms. b. at low levels of output, AFC will be
high, while at high levels of output, MC will be
high as the result of diminishing
returns. c. diminishing returns will be present
when output is small, and high AFC will push
per-unit cost to high levels when output is
large. d. diseconomies of scale will be present
at both small and large output rates.
5. When costs that vary with the level of output
are divided by the output, you have
calculated a. total changing cost.
b. total fixed cost. c. average fixed cost.
d. average variable cost.
6. In the short run, if average variable cost
equals 50, average total cost equals 75, and
output equals 100, the total fixed cost must be
a. 25. b. 2,500.
c. 5,000. d. 7,500.
30

• At what output in the graph would the firms
  per-unit cost of production be minimized?
• 3 b. 4 c. 5
  d. 6

b. 4

• What is the firms approximate total cost when it
  produces three units?
• 10 b. 16 c. 48
  d. 60

c. 48

• What is the firms total cost when it produces
  four units?
• 11 b. 15 c.
  60 d. 75

c. 60
The average variable cost and average total cost
for a firm are indicated in the graph. If the
marginal cost curve were constructed, at what
output would it cross the AVC curve?
b. 15

1. 10 b. 15 c. 20 d.
   25

At what output should a the marginal cost curve
cross the ATC curve?

1. 15 b. 20 c.
   25 d. 30

b. 20