macroeconomic mcgrowhill micro ch 7 19e use this one

Copyright 2008 The McGraw-Hill Companies• Why Do Economic Costs Include Both Explicit Costs and Implicit Costs • How Does the Law of Diminishing Returns Relate to a Firm’s Run Producti

Businesses and the Costs

of Production

07

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved.

Copyright 2008 The McGraw-Hill Companies

• Why Do Economic Costs Include

Both Explicit Costs and Implicit Costs

• How Does the Law of Diminishing

Returns Relate to a Firm’s Run Production Costs

Short-• Learn the Distinctions Between

Fixed and Variable Costs and Among Total, Average, and

Marginal Costs

• Learn the Link Between a Firm’s

Size and Its Average Costs in the Long Run

• Normal Profit as a Cost

• Economic or Pure Profit

Economic

W 8.1

Copyright 2008 The McGraw-Hill Companies

• Equal to opportunity costs

• Explicit + implicit costs

8-4

–Equal to implicit cost

• Economic or pure profit

–Total revenue less economic

cost

Copyright 2008 The McGraw-Hill Companies

Accounting Costs (Explicit Costs Only)

Accounting Profit

Explicit Costs

Implicit Costs (Including a Normal Profit)

Short Run and Long Run

•Short Run: Fixed Plant

•Long Run: Variable Plant

upon annual chronology

Copyright 2008 The McGraw-Hill Companies

Short and Long Run

• The short run

–Fixed plant capacity –Variable intensity of plant use

–Variable output

• The long run

–Variable plant capacity –Firms enter and exit

8-8

• Average Product (AP)

Average Product Total Product

Units of Labor

=

Marginal Product Change in Total Product

Change in Labor Input

=

W 8.2

Copyright 2008 The McGraw-Hill Companies

Law of Diminishing Returns

• Rationale

• Tabular Example

(1) Units of the Variable Resource

(Labor)

(2) Total Product

(TP)

(3) Marginal Product

(MP), Change in (2)/

Change in (1)

(3) Average Product (AP), (2)/(1) 0

1 2 3 4 5 6 7 8

0 10 25 45 60 70 75 75 70

10 15 20 15 10 5 0 -5

10.00 12.50 15.00 15.00 14.00 12.50 10.71 8.75

-] ] ] ] ] ] ] ]

Diminishing Marginal Returns Negative Marginal Returns

O 8.1

Copyright 2008 The McGraw-Hill Companies

Increasing Marginal Returns

Diminishing Marginal Returns

Negative Marginal Returns

O 8.2

Average Fixed Costs = Total Fixed Costs Quantity

Variable Costs Total Variable Costs

Average Variable Costs = Total Variable Costs Quantity

SHORT-RUN PRODUCTION COSTS

Copyright 2008 The McGraw-Hill Companies

Short-Run Production Costs

• Per-Unit or Average Costs

–Average Fixed Cost (AFC) –Average Variable Cost

(AVC) –Average Total Cost (ATC) –Marginal Cost (MC)

Copyright 2008 The McGraw-Hill Companies

End Show Marginal Cost = MC

Total Fixed Costs = TFC

Total Variable Costs = TVC

Average Variable Costs = AVC

Total Costs = TC

Average Total Costs = ATC

Average Fixed Costs = AFC

Short-Run Production Costs

Total Cost, Fixed and Variable Costs

$1100

TFC

TC TVC

Total Cost Variable Cost

Fixed Cost

Copyright 2008 The McGraw-Hill Companies

Short-Run Production Costs

Average and Marginal Costs

$200

AFC

MC

ATC AVC

AVC AFC

G 8.1

Short-Run Production Costs

• MC and Marginal Product

Copyright 2008 The McGraw-Hill Companies

Production Curves

Cost Curves

Long-Run Production Costs

• Firm Size and Costs

• Long-Run Cost Curve

• Economies of Scale

–Labor Specialization –Managerial Specialization –Efficient Capital

• Diseconomies of Scale

• Constant Returns to Scale

Copyright 2008 The McGraw-Hill Companies

Long-Run Production Costs

• Choose your plant size

• Minimize ATC

• Different ATC curves

–Short run

• Long run ATC

–Envelope of short run ATC

8-22

Long-Run Production Costs

Long-Run ATC Curve

Copyright 2008 The McGraw-Hill Companies

Long-Run Production Costs

Long-Run ATC Curve

Long-Run ATC

The Long-Run ATC Curve Just

“Envelopes” the Short Run ATCs

Long-Run Production Costs

Long-Run ATC Curve

Long-Run ATC

The Long-Run ATC Curve Just

“Envelopes” the Short Run ATCs

Copyright 2008 The McGraw-Hill Companies

Long-Run Production Costs

Alternative Long-Run ATC Shapes

Economies and Diseconomies of

Economies and Diseconomies of

MES and Industry Structure

• Minimum Efficient Scale (MES):

• Lowest level of output where long- run average costs are minimized

• Can determine the structure of the industry

Copyright 2008 The McGraw-Hill Companies

Long-Run Production Costs

Alternative Long-Run ATC Shapes

Output

Long-Run ATC Curve Where Costs Are Lowest Only When Large Numbers Are Participating

Long-Run Production Costs

Alternative Long-Run ATC Shapes

Output

Long-Run ATC Curve Where Economies

Of Scale Exist, are Exhausted Quickly, And Turn Back Up Substantially

Economies

Of Scale

Diseconomies

Of Scale

Copyright 2008 The McGraw-Hill Companies

• Applications and Illustrations

– Rising Cost of Insurance and Security

– Successful Start-Up Firms – The Verson Stamping Machine – The Daily Newspaper

– Aircraft and Concrete Plants

O 8.3

Don’t Cry Over Sunk Costs

• Sunk Costs Irrelevant in

• Previously Incurred Costs Do

Not Impact the MB=MC Decision

• Sunk Costs Are Irrelevant!

Copyright 2008 The McGraw-Hill Companies