Chapter 8 Production and Costs

1
Chapter 8Production and Costs
2
Marginal Physical Product (MPP)

• What is the variable input?
• What is the variable cost?

3
So

• As more labor (VARIABLE INPUT) are added to land
  (FIXED INPUT) the variable inputs would yield
  smaller and smaller additions to output

4
Marginal Physical Product
5
Crowding Problem

• The point at which MPP declines
• Shows the law of diminishing returns

6
Average Physical Productivity

• Output divided by Inputs (usually labor)
• Good for comparing firms or countries.

7
So find that

• MC and MPP are related
• What is the relationship?

8
In class exercise 10 Does MPP show Diminishing
Returns???

9
Law of Diminishing Marginal Returns
10
Marginal Cost
11
Does this relationship make sense?

• Yes..
• If productivity increases what would happen to
  costs??
• Decrease (MPP increase MC decrease)
• Productivity decreases??
• Increase (MPP decreases MC increases)

12
MPP determines shape of MC

• MPP must have a declining part because of
  diminishing returns
• Can also define MC as

13
In-class exercise 11

• How do we calculate these costs??
• Give two ways to get to the cost

14
Average-Marginal Rule

• Can use to see what the ATC and AVC curve look
  like
• Tells us what happens when MC is above or below
  the average curves
• If MC is above AVC and ATC
• AVC and ATC are rising
• If MC is below AVC and ATC
• AVC and ATC are falling

15
From Average-Marginal Rule can infer

• MC intersects the AVC and ATC curves at their
  MINIMUM POINTS
• Cannot infer anything about AFC

16
Average and Marginal Cost Curves
17
Average and Marginal Cost Curves
18
So

• MC gains it shape from???
• MPP and law of diminishing marginal returns
• MC below ATC What is ATC curve doing?
• Falling
• MC above ATC What is ATC curve doing?
• Rising

19
Average and Marginal Cost Curves
20
Tying Products to Costs
A CLOSER LOOK
MPP Variable Input
When MC is below ATC, AVC
MC
Production in the short run at least one fixed
input
When MC is above ATC, AVC
MPP Variable Input
MC
21
Now switching to the Long Run

• When does Long Run start?
• As soon as all inputs (costs) are VARIABLE
• No fixed costs
• Important curves
• LRTC
• LRATC
• LRMC

22
Short Run vs. Long Run

• Short Run assumes FIXED plant size
• Each plant size has a unique ATC curve associated
  with it
• SRATC
• LRATC combines all the SRATC curves
• Which points of the SRATC???
• Minimum points

23
Why minimum?

• LRATC shows the lowest average cost at which a
  firm can produce any given level of output
• LRATC is the lower ENVELOPE of the SRATC curves
• Called envelope curve

24
Long-Run Average Total Cost Curve (LRATC)
25
Isnt the LRATC curve smooth??

• Yes!!
• Have infinitely many SRATC curves so it would be
  smooth if use all curves
• Each SRATC curve touches the LRATC curve only once

26
Shape of LRATC

• U-shaped
• Decreasing, Flat, then Increasing
• Important when finding optimal long run output
  level

27
Long-Run Average Total Cost Curve (LRATC)
28
Economies of Scale

• Downward part of LRATC
• Average costs decrease as output increases
• If have a 1 increase in input usage what happens
  to output??
• Increases by MORE than 1
• Specialization

29
Constant Returns to Scale

• Flat portion of LRATC
• Costs remain the same as increase output
• If have a 1 increase in input usage what happens
  to output??
• Output increases by EXACTLY 1
• First point of constant returns to scale is
  called MINIMUM EFFICIENT SCALE

30
Diseconomies of Scale

• Upward sloped portion of LRATC
• Costs are rising as we increase output
• If have a 1 increase in input usage what happens
  to output?
• Increases by LESS THAN 1
• Why???
• Firm too large (bad communication or coordination
  problems)

31
Long-Run Average Total Cost Curve (LRATC)
32
Are economies, diseconomies, and constant returns
to scale in SR, LR, or both???

• LONG RUN ONLY!!!
• Why?
• Inputs necessary for production are able to be
  changed
• No fixed inputs

33
Is this the same as diminishing returns?

• NO
• Diminishing returns is from using ONE plant size
  intensely
• Short run
• Economies of scale is from CHANGING plant size
• Long run

34
Review

• Economies of Scale
• LRATC falling
• Constant Returns to Scale
• LRATC flat
• Diseconomies of Scale
• LRATC rising

35
Why does economies of scale exist?

• Large firms offer more opportunity for workers to
  specialize
• Growing firms can take advantage of efficient
  mass production techniques
• Smooth cost over more units produced

36
Why does diseconomies of scale exist?

• Communication problems
• Shirking
• Management problems

37
Why is minimum efficient scale important?

• Lowest output level at which ATC are minimized
• Which has a cost advantage??
• Small firm at minimum efficient scale point
• Larger firm producing more output but still
  within constant returns to scale area
• Neither

38
Long-Run Average Total Cost Curve (LRATC)
39
Minimum Efficient Scale for Six Industries
40
Where would you expect to find less firms? (using
MES)

• Firms with higher MES
• Why??
• Produce until MES
• If MES is higher then each firm will be producing
  moreso need less firms to cover quantity wanted
  by economy
• Many SHOE companies (MES .2)
• Few REFRIGERATOR companies (MES 14)

41
Efficient Number of Firms

• 100 divided by MES
• 100 of goods are wanted by consumers
• MES is the percentage of consumption each firm
  will provide
• Cigarette firms MES 6.6
• Need 15 firms
• Petroleum firms MES 1.9
• Need 52 firms
• Thus a larger MES means less firms needed

42
What cause SRTC, LRTC, and MC to shift?

• Taxes
• Does it affect FC??
• Only if it is a lump sum tax (tax for existing)
• If it is a per unit tax then FC doesnt change
• How does it change curves??
• Input prices
• How does it change curves??
• Technology
• Either improves production process (use less
  inputs) or lower input prices
• How does it change curves??

43
Homework

• Chapter 8
• Questions 3, 5, 10, and 11
• Working with numbers and graphs
• Questions 3, 6, and 7

44
In-class exercise 12

• Do we understand Chapter 8??