production cost and revenue

The lecture answers the following questions 1. What is the relationship between a firm’s total revenue, profit, and total cost? 2. Give an example of an opportunity cost that an accountant might not count as a cost. Why would the accountant ignore this cost? 3. What is marginal product, and what does it mean if it is diminishing? 4. Draw a production function that exhibits diminishing marginal product of labor. Draw the associated totalcost curve. (In both cases, be sure to label the axes.) Explain the shapes of the two curves you have drawn. 5. Define total cost, average total cost, and marginal cost. How are they related? 6. Draw the marginalcost and averagetotalcost curves for a typical firm. Explain why the curves have the shapes that they do and why they cross where they do. 7. How and why does a firm’s averagetotalcost curve differ in the short run and in the long run?

PRODUCTION COST AND REVENUE

1 PRODUCTION COST

private costs

(Chi phí tư nhân)

explicit costs (Chi phí hiện)

accounting costs (Chi phí kế toán)

economic costs (Chi phí kinh tế)

implicit costs (Chi phí ẩn) external costs

(Chi phí ngoại

tác)

Private costs are the costs that the buyer of a good or service pays the seller This can also

be described as the costs internal to the firm's production function

External costs (also called externalities), in contrast, are the costs that people other than the

buyer are forced to pay as a result of the transaction Chi phí hiện (explicit costs): là chi phí trả cho nguồn lực không phải của doanh nghiệp sở hữu

 Chi phí ẩn (implicit costs): là chi phí trả cho các nguồn lực mà của doanh nghiệp sở hữu

 Chi phí kế toán (accounting cost) là chi phí thực tế phát sinh Nó bao gồm tất cả các chi phí hiện và một phần của chi phí ẩn

 Chi phí kinh tế (economic cost) là chi phí sử dụng các nguồn lực kinh tế trong sản xuất của một doanh nghiệp, bao gồm cả chi phí cơ hội

2 PRODUCTION COST IN THE SHORT RUN

Definition of Costs:

Fixed Costs, Variable Costs, and Total Costs

 Fixed costs (FC) are those that are spent and cannot be changed in the period of time

under consideration

Notes:

 In the long run there are no fixed costs since all costs are variable

 In the short run, a number of costs will be fixed

 Variable costs (VC) are expenses that change in proportion to the activity of a business.

Variable costs are sometimes called unit-level costs as they vary with the number of units produced

 Total costs (TC) are the sum of the variable and fixed costs

TC = FC + VC

Average Costs:

 Average fixed cost (AFC) equals fixed cost divided by quantity produced

AFC = FC/Q

 Average variable cost (AVC) equals variable cost divided by quantity produced

AVC = VC/Q

 Average total cost (ATC) can also be thought of as the sum of average fixed cost and

average variable cost

ATC = AFC + AVC or

 Marginal cost (MC) is the increase (decrease) in total cost of increasing (or decreasing) the level of output by one unit

Note: In deciding how many units to produce, the most important variable is marginal cost

Marginal cost  the change in cost caused by a change in output, derived by dividing

the change in total cost by the change in the quantity of output

output Total

cost Total

=

ATC

output of

quantity

in Change

cost

in total Change

=

MC

Example of Costs:

Graphing Cost Curves

Quantity is put on the horizontal axis and a dollar measure of various costs on the vertical axis

Average and Marginal Cost Curves:

 The marginal cost curve goes through the minimum point of the average total cost curve and average variable cost curve

 Each of these curves is U-shaped

 The average fixed cost curve slopes down continuously

The average fixed cost curve looks like a child’s slide – it starts out with a steep decline, then it becomes flatter and flatter

It tells us that as output increases, the same fixed cost can be spread out over a wider range of output

The U Shape of the Average and Marginal Cost Curves:

 When output is increased in the short-run, it can only be done by increasing the variable input

 The law of diminishing marginal productivity sets in as more and more of a variable input is added to a fixed input

 Marginal and average productivities fall and marginal costs rise

 And when average productivity of the variable input falls, average variable cost rises

 If the firm increased output enormously, the average variable cost curve and the average total cost curve would almost meet

 The firm’s eye is focused on average total cost - it wants to keep it low

 The average total cost curve is the vertical summation of the average fixed cost curve and the average variable cost curve

Relationship Between Marginal and Average Costs

 The marginal cost and average cost curves are related

 When marginal cost exceeds average cost, average cost must be rising

 When marginal cost is less than average cost, average cost must be falling

If MC > ATC, then ATC is rising.

If MC = ATC, then ATC is at its low point.

If MC < ATC, then ATC is falling.

 Average variable cost reflect a general relationship that also holds for marginal cost and average variable cost

If MC > AVC, then AVC is rising.

If MC = AVC, then AVC is at its low point.

If MC < AVC, then AVC is falling.

3 PRODUCTION REVENUE

 Marginal revenue (MR) is the additional revenue added by an additional unit of output,

or in terms of a formula:

Marginal Revenue = (Change in total revenue) divided by (Change in sales)

MR = δTR/δQ

Supposed: Q = a –bP  P = a/b – 1/bQ

 TR = P*Q = a/b*Q – Q2/b  MR = a/b – 2Q/b

Why is the marginal revenue curve below the demand curve and why does the vertical distance between them diverge as output increases?

 Total revenue (TR) is the total number of dollars received by a firm from the sale of a

product

TR = P x Q

 Average revenue (AR) is total revenue divided by the quantity sold.

Notes:

 For all firms, average revenue equals the price of the good.

 For competitive firms, marginal revenue equals the price of the good.

4 PRODUCTION FUNCTION

 Production function shows the relationship between quantity of inputs used to make a

good and the quantity of output of that good

 Marginal product is the increase in output that arises from an additional unit of input

 Diminishing marginal product is the property whereby the marginal product of an

input declines as the quantity of the input increases

A production function shows the relationship between the number of workers hired and the quantity of output produced Here the number of workers hired (on the horizontal axis) is from the first column in the Table, and the quantity of output produced (on the verticalaxis)

is from the second column The production function gets flatter as the number of workers increases, which reflects diminishing marginal product

5 PROFIT MAXIMIZATION

Profit generally is the making of gain in business activity for the benefit of the owners of the

business

Profit = Total Revenue – Total Cost

= TR – TC

How firms maximize their profit: Firms adjust their volume subjected to MR = MC

 The goal of firms is to maximize profit, which equals total revenue minus total cost

 When analyzing a firm’s behavior, it is important to include all the opportunity costs of production Some of the opportunity costs, such as the wages a firm pays its workers, are explicit Other opportunity costs, such as the wages the firm owner gives up by working in the firm rather than taking another job, are implicit

 A firm’s costs reflect its production process A typical firm’s production function gets flatter as the quantity of an input increases, displaying the property of diminishing marginal product As a result, a firm’s total-cost curve gets steeper as the quantity produced rises

 A firm’s total costs can be divided between fixed costs and variable costs Fixed costs are costs that do not change when the firm alters the quantity of output produced Variable costs are costs that do change when the firm alters the quantity of output produced

 From a firm’s total cost, two related measures of cost are derived Average total cost is total cost divided by the quantity of output Marginal cost is the amount by which total cost would rise if output were increased by 1 unit

 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 quantity of output

 Average total cost first falls as output increases and then rises as output increases further The marginal-cost curve always crosses the average-total-cost curve at the minimum of average total cost

 A firm’s costs often depend on the time horizon being considered In particular, many costs are fixed in the short run but variable in the long run As a result, when the firm changes its level of production, average total cost may rise more in the short run than in the long run

QUESTIONS AND APPLICATIONS

1 What is the relationship between a firm’s total revenue, profit, and total cost?

2 Give an example of an opportunity cost that an accountant might not count as a cost Why would the accountant ignore this cost?

3 What is marginal product, and what does it mean if it is diminishing?

4 Draw a production function that exhibits diminishing marginal product of labor Draw the associated totalcost curve (In both cases, be sure to label the axes.) Explain the shapes of the two curves you have drawn

5 Define total cost, average total cost, and marginal cost How are they related?

6 Draw the marginal-cost and average-total-cost curves for a typical firm Explain why the curves have the shapes that they do and why they cross where they do

7 How and why does a firm’s average-total-cost curve differ in the short run and in the long run?

1 Fill in the table with suitable numbers and derive the FC, AFC, AVC, ATC curves

2 This chapter discusses many types of costs: opportunity cost, total cost, fixed cost, variable cost, average total cost, and marginal cost Fill in the type of cost that best completes the phrases below:

a The true cost of taking some action is its _

b _ is falling when marginal cost is below it, and rising when marginal cost is above it

c A cost that does not depend on the quantity produced is a _

d In the ice-cream industry in the short run, _ includes the cost of cream and sugar, but not the cost of the factory

e Profits equal total revenue less _

f The cost of producing an extra unit of output is _

3 Your aunt is thinking about opening a hardware store She estimates that it would cost

$500,000 per year to rent the location and buy the stock In addition, she would have to quit her

$50,000 per year job as an accountant

a Define opportunity cost

b What is your aunt’s opportunity cost of running a hardware store for a year? If your aunt thought she could sell $510,000 worth of merchandise in a year, should she open the store? Explain

4 Suppose that your college charges you separately for tuition and for room and board

a What is a cost of attending college that is not an opportunity cost?

b What is an explicit opportunity cost of attending college?

c What is an implicit opportunity cost of attending college?

5 A commercial fisherman notices the following relationship between hours spent fishing and the quantity of fish caught:

HOURS QUANTITY OF FISH (IN POUNDS)

0 0

a What is the marginal product of each hour spent fishing?

b Use these data to graph the fisherman’s production function Explain its shape

c The fisherman has a fixed cost of $10 (his pole) The opportunity cost of his time is $5 per hour Graph the fisherman’s total-cost curve Explain its shape

6 Nimbus, Inc., makes brooms and then sells them door - to - door Here is the relationship between the number of workers and Nimbus’s output in a given day:

a Fill in the column of marginal products What pattern do you see? How might you explain it?

b A worker costs $100 a day, and the firm has fixed costs of $200 Use this information to fill

in the column for total cost

c Fill in the column for average total cost (Recall that ATC = TC/Q.) What pattern do you see?

d Now fill in the column for marginal cost (Recall that MC = TC/Q.) What pattern do you

see?

e Compare the column for marginal product and the column for marginal cost Explain the relationship

f Compare the column for average total cost and the column for marginal cost Explain the relationship

7 Suppose that you and your roommate have started a bagel delivery service on campus List some of your fixed costs and describe why they are fixed List some of your variable costs and describe why they are variable

8 Consider the following cost information for a pizzeria:

Q (DOZENS) TOTAL COST VARIABLE COST

4 450 150

a What is the pizzeria’s fixed cost?

b Construct a table in which you calculate the marginal cost per dozen pizzas using the

information on total cost Also calculate the marginal cost per dozen pizzas using the

information on variable cost What is the relationship between these sets of numbers?

Comment

9 You are thinking about setting up a lemonade stand The stand itself costs $200 The

ingredients for each cup

of lemonade cost $0.50

a What is your fixed cost of doing business? What is your variable cost per cup?

b Construct a table showing your total cost, average total cost, and marginal cost for output levels varying from zero to 10 gallons (Hint: There are 16 cups in a gallon.) Draw the three cost curves

10 Healthy Harry’s Juice Bar has the following cost schedules:

Q (VATS) VARIABLE COST TOTAL COST

a Calculate average variable cost, average total cost, and marginal cost for each quantity

b Graph all three curves What is the relationship between the marginal-cost curve and the averagetotal-cost curve? Between the marginal-cost curve and the average-variable-cost curve? Explain