Bài giảng topic 4 production costs

Profit concepts Accounting profit =Total revenue – Total Explicit costs  Economic profit = Total revenue – Total Explicit costs + Total Implicit costs = Total revenue – Opportunity cos

Topic 4

Production and Costs

PRODUCTION & COSTS

1 Production & Costs concepts

2 Short run Costs

3 Long Run Costs

1 Some cost concepts

Opportunity Cost

 Opportunity cost:

The benefit foregone, or opportunity lost, by not using resources in their best alternative use

 Real Opportunity cost:

 Maximum quantity of output forgone

 Money Opportunity cost

 Maximum value of output forgone

1 Some cost concepts

Explicit Vs Implicit Cost

1 Profit concepts

 Accounting profit

=Total revenue – Total Explicit costs

 Economic profit

= Total revenue – (Total Explicit costs + Total Implicit costs)

= Total revenue – Opportunity costs of all resources used

 Normal profit

= Zero Economic profit or breaking even

= The minimum cost payment just sufficient to keep the firm in business

Bill runs a computer shop as a sole proprietorship The following

data are about his financial matters in his first year of business.

Calculate Bill's accounting profit and economic profit for his first year of business.

$

190,000 Total revenue

65,000 Salary that Bill could have earned if he had worked for

another firm 90,000 Loan from a bank

9,000 Interest paid to the bank

70,000 Purchase of durable assets with his own money

4,200 Dividend that he could have earned by investing his

$70,000 in shares 14,000 Depreciation of the durable assets

30,000 Salary for an assistant

67,000 Raw materials used

1 Short- Run Vs Long-Run

 the time frame in which

at least one input factor is fixed

 the time frame in which

all input factors are variable

There is no fixed calendar definition of long or short run– it depends!

2 Short Run Production

 Assume all factors fixed, except labour

 Average Product of labour (AP L ) is the total product output per unit of labour

where: Q is the total product output

L is no of labour units

2 Short Run Production

 Marginal product of labour (MP L ) is the additional product output resulting from

an extra unit of labour

∆Q is the change in product output

∆L is no of units of labour

 TP = Q = Total product or Total output

Wheat production per year from a

particular farm (tonnes)

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Law of Diminishing

Returns

labor) are added to a fixed resource (say, land), beyond some point the marginal product (MP)

attributable to each additional unit of the variable resource will decline." (Jackson, p.228)

Law of Diminishing

Returns

Assuming…

 A variable resource (labour) is added

to set of fixed resources (plants and machinery)

 technology is given

Law of Diminishing

Returns

 As units of a variable resource are added to a set

of fixed resource, with technology constant, the marginal product of the variable resource must

eventually diminish

 That is, when the optimal combination between labour and fixed resources has been reached, any further addition of labour means that each worker will have less and less of the plants & machinery

to work with, and so they must become less and less efficient

0 10 20 30 40

Wheat production per year from a particular farm

Copyright 2001 Pearson Education Australia

0 10 20 30 40

0 10

Wheat production per year from a particular farm

Copyright 2001 Pearson Education Australia

The Production Curves

 MP cuts through AP at the maximum AP

 When marginal >

average, average is increasing

 When marginal falls below average, average starts falling too.

 When MP > 0, TP increasing

 When MP < 0, TP decreasing

 When MP = 0, TP is at its maximum

To practice what we’ve done

so far…

Short run Costs

 Total Costs

 Total Fixed Cost TFC

 Total Variable Cost TVC

 Total Cost TC = TFC + TVC

 Average Costs

 Average fixed cost (AFC) = TFC/Q

 Average Variable cost (AVC) = TVC/Q

 Average Total cost (ATC) = TC/Q = AFC+AVC

Fixed Cost

TVC

Variable Cost

TFC

Short run Costs

 Marginal Cost (MC) is the extra cost of

producing one more unit of a product

 MC = ∆TC / ∆Q

 MC = ∆TVC / ∆Q

Marginal Cost Relationships

Cost Relationships

Relationship b/w

TVC, TFC & TC MC cuts both AVC & ATC at their minimum points

AFC is decreasing

2.To practice what we’ve done

so far…

3 LONG-RUN THEORY OF PRODUCTION

production are variable

LONG-RUN THEORY OF PRODUCTION

Economies of Scale

Output O

LONG-RUN THEORY OF PRODUCTION

 Diseconomies of scale

As firm increases its scale of output, LRAC increases

 Reasons:

 Over specialization of labor

 Managerial Problems- Bureaucracy

 Access to Materials

 Access to skilled labours

Output O

Output O

Constant Return to scales

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of scale

A typical long-run average cost curve

Minimum Efficient Scale (MES)

Definition:

which a firm can minimize its LR average costs.

 MES occurs at q1 unit of output

Constructing long-run average cost

curves: factories of fixed size

1 factory

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2 factories

Constructing long-run average cost

curves: factories of fixed size

3 factories

Constructing long-run average cost curves:

factories of fixed size

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5 factories

4 factories

Constructing long-run average cost curves:

factories of fixed size

Constructing long-run average cost curves:

factories of fixed size

Copyright 2001 Pearson Education Australia

Assuming a virtually unlimited number of plant sizes, LRAC curve takes on a smoother shape