Chapter 12: The costs of production. In this chapter you will learn: How to define total revenue, total cost, and profit? How to calculate economic and accounting profit? How to define marginal product and show diminishing marginal product? How to define average and marginal cost?...
Trang 1© 2014 by McGraw-Hill Education 1
Chapter 12
The Costs of Production
What will you learn in this chapter?
• How to define total revenue, total cost, and profit.
• How to differentiate between:
• How to calculate economic and accounting profit.
• How to define marginal product and show
diminishing marginal product.
• How to define average and marginal cost.
• How to think about long-run and short-run costs.
• How to define returns to scale and its
implications.
Revenues, costs, and profits
• A firm’s goal is to maximize profits:
Profit = Total revenue – Total cost
sale of goods and services and is calculated as the quantity
sold multiplied by the price paid for each unit:
Total revenue = Quantity x Price = (Q1xP1) + (Q2xP2) + … +
(QnxPn)
• Total cost is the amount thata firm pays for inputs used to
produce goods or services
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Active Learning: Calculating total revenue
10,000 gumball machines Calculate total
revenue
Fixed and variable costs
• A firm’s total cost is defined as:
Total costs = Fixed costs + Variable costs
quantity of output produced.
like buying equipment
• Fixed costs are constant as quantity increases.
• Even if a firm produces nothing, it still incurs a
fixed cost.
Fixed and variable costs
• Variable costs are those that depend on the
quantity of output produced.
additional unit produced.
zero.
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Fixed and variable costs
This table provides the fixed and variable costs for a firm
Quantity of pills
(millions)
100,000 0 0
200,000 300,000 400,000 500,000 600,000 700,000 800,000
30
40
50
60
70
80
10
20
1,000,000
1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
1,000,000 1,000,000
1,000,000
1,300,000 1,400,000 1,500,000 1,600,000 1,700,000 1,800,000
1,100,000 1,200,000
Total costs ($) Variable costs ($) Fixed costs
($)
• As the quantity produced increases, the fixed costs remain
constantand the variable costs increase
Active Learning: Calculating costs
Fill in the table assuming fixed costs are $1,000 and variable costs
are $20 per unit
Quantity
0
30
40
50
60
70
80
10
20
Total costs ($) Variable costs ($) Fixed costs
($)
Explicit and implicit costs
• A firm’s opportunity cost of operation has two
components.
• The first is composed of the fixed and variable
costs.
money
• The second is composed of forgone opportunities.
that could have generated revenue if the firm had
invested its resources in another way
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Economic and accounting profit
• When companies report their profits, they
provide accounting profits :
Accounting profit = Total revenue – Explicit costs
• Accounting profits may be a misleading indicator
of how well a business is really doing.
• To account for implicit costs, economic profit
further subtracts implicit costs:
Economic profit = Accounting profit – Implicit costs
Economic and accounting profit
The following dialog illustrates why economic profits matter
Executive B: But you’re forgetting
about all of the other things we could
do with $10 million By my
calculations, we could earn $6 million
in interest over the next 10 years of
we invested the money That means
that the true cost of buying the facility
be only $13 million If we bought the
factory, we could lose $3 million!
Executive A: The new facility would cost $6
million to buy and $4 million to operate over the next decade, for a total cost of $10 million The medicines we could produce there would bring in
in profits Buy the factory!
CEO: We have the
opportunity to buy a
new manufacturing
facility Is this a smart
move for you
company?
Total production, marginal product, and
average product
ingredients to create a good or service that consumers
want
• A production function is the relationship between the
quantity of inputs and the resulting quantity of outputs
–The principle of diminishing marginal productstates that
the marginal product of an input decreases as the quantity
of the input increases
number of workers
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Total production and marginal product
This table provides the total production and marginal product from each
additional unit of labor.
Labor
(# employees)
Total production (# pizzas)
Marginal product of labor (# pizzas) 0
1
2
8
7
6
5
3
4
50 180 360
800 735 660
480 575
0 50 130
65 75 85 95
180 120 0
• The first three workers have an increasing marginal product After three workers, each
additional worker contributes less to total production, reflected by decreasing marginal
product.
• Note that even though marginal product of labor is decreasing, total production is still rising.
Active Learning: Total production,
marginal product, and average product
Fill in the table At what point does marginal product start to
diminish?
Average product Labor
(# employees) Total production
0
1
2
8
7
6
5
3
4
20 45 75
150 145 135
100 120
0 Marginal product
Production function
• The production function can be represented visually
• The marginal product is the slope of the total production curve
300
400
500
600
700
800
900
1,000
Quantity of pizzas
Curve gets
steeper as
marginal
Curve flattens as
diminishing marginal
product kicks in.
Total production
each additional worker has a highermarginal product than the previous one
added, marginal product starts to diminish
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Average and marginal product
• The principle of diminishing marginal product and average product
can be represented visually
• This establishes the relationship between marginal and average
product
Quantity of pizzas
Quantity of workers
Marginal product
2 Eventually, marginal
product starts to
decrease.
1 Initially, adding more
workers increases
marginal product.
0
25
50
75
100
125
150
175
200
Average product
marginal product is greater than the existing average product, the average product increases
crosses the average product curve, the average product also starts to decrease
marginal product is less than the existing average product, the average product decreases
Costs of production
• When a firm increases its output by adjusting its use of inputs, it
incurs the costs associated with that decision
• The relationships between output and costs are:
Average fixed cost (AFC)=
Average variable cost (AVC) =
Average total cost (ATC) = = AFC + AVC
Marginal cost (MC) =
Costs of production
The table below provides the production and costs of a pizza joint that requires
a lease for $300 and wages for workers at $200 each.
6 660 300 0.45 1,200 1.82 1,500 2.27 85 2.35
9 855 300 0.35 1,800 2.11 2,100 2.46 55 3.67
10 900 300 0.33 2,000 2.22 2,300 2.55 45 4.44
8 800 300 0.38 1,600 2.00 1,900 2.38 65 3.08
7 735 300 0.41 1,400 1.90 1,700 2.31 75 2.67
5 575 300 0.52 1,100 1.74 1,300 2.26 95 2.11
4 480 300 0.63 800 1.67 1,100 2.30 120 1.61
3 360 300 0.83 600 1.67 900 2.50 180 1.11
2 180 300 1.67 400 2.22 700 3.89 130 1.54
1 50 300 6.00 200 4.00 500 10.00 50 4.00
– –
Labor
(# workers)
Total
production
(# pizzas)
Fixed
($)
Average fixed costs ($/pizza) Variable costs ($) Average variable costs ($/pizza) Total costs ($) Average total costs ($/pizza) Marginal product (# pizzas) Marginal cost ($/pizza)
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Cost curves
Cost functions can be represented visually.
0
500
1,000
1,500
2,000
2,500
Quantity of pizzas
TC
Cost ($)
FC
VC
Because of diminishing marginal product, variable costs increase more as each additional pizza is added.
Fixed costs, on the other hand, stay the same regardless of how many pizzas are produced.
The total cost curve is the sum of variable and fixed costs.
• The VC curve initially becomes less steep , reflecting the increasing marginal product of the first few employees.
• As the principle of diminishing marginal product kicks in, the variable cost curve gets gradually steeper.
• Adding FC and VC yields TC.
Cost curves
Average costs can be represented visually.
–Same cost spread out over more units of output
–First decreases and then increases, reflecting the marginal product of inputs
–Decreases in AFC and increases with AVC
0
1
2
3
4
5
6
7
8
9
10
Quantity of pizzas
ATC
AFC AVC
Cost/pizza ($)
Cost curves
Marginal cost can be represented visually.
and is the inverse shape of the marginal product curve
–Every additional unit of input costs the same, regardless of its contribution to production
–As marginal product of labor initially increases, MC
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00
MC Cost / pizza ($)
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producing another unit is less than the ATC, producing an extra unit
decreasesthe ATC
producing another unit is more than the average total cost, producing an extra unit will increasethe ATC
the ATC curve at its lowest
point
Marginal and average cost curves
0
1
2
3
4
5
6
7
8
9
10
Quantity of pizzas
MC
ATC
Cost/pizza ($)
The relationship between marginal and average
total cost can be established visually.
Summarizing costs
The following summarizes various costs
Cost
Total cost (TC)
The amount that a firm pays for all of the inputs (fixed and variable) that go into producing goods and services Fixed cost (FC) Costs that don’t depend on the quantity ofoutput produced —
Variable cost (VC) Costs that depend on the quantity of outputproduced —
Explicit cost Costs that require a firm to spend money —
Implicit cost Costs that represent forgone opportunities —
MC = DTC / DQ
ATC = TC / Q
AVC = VC / Q
AFC = FC / Q
TC = FC + VC
Total costs divided by the quantity of output Variable costs divided by the quantity of output
Fixed costs divided by the quantity of output Average fixed costs
(AFC)
Average variable costs
(AVC)
Average total costs (ATC)
Marginal cost (MC) The additional cost incurred by a firm when it
produces one additional unit of output
Active Learning: Costs
Fill in the table, assuming that a lease for a building is $300 and
workers’ wages are $100 each
10 165
8 150
6 135
4 100
– –
Labor
(# workers)
Total
production
(# pizzas)
Fixed ($) Average fixed costs ($/pizza) Variable costs ($) Average variable costs ($/pizza) Total costs ($) Average total costs ($/pizza) Marginal cost ($/pizza)
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Costs in the long run
–For example, factory sizes can be adjusted to increase or
decrease capacity
its costs, if so desired
curves
fixed cost curve shifts, as it is more efficient and can
produce higher output
Returns to scale
scale of production
–The planet size or scale of production to produce a certain
amount of output
• If increasing the scale of production to obtain higher output
lowers the minimum of the average total cost, then
economies of scaleoccur
• If increasing the scale of production to obtain higher output
raises the minimum of the average total cost, then
diseconomies of scaleoccur
average total cost does not depend on the quantity of
output
–When the average total cost is at its minimum, an efficient scale
is achieved
Active Learning: Economies and
diseconomies of scale
Match each segment of the long-run ATC with its respective scale
or production (economies, constant, and diseconomies)
Average total cost Long-run
ATC
Trang 10Long‐run ATC
cover a smaller range of output
decreasing scale of production, firms can move along the long‐run ATC curve from one short‐
run ATC curve to another
The long‐run ATC curve is constructed by combining all possible short‐
run ATC curves
Short‐run ATC curves are identified by changing the scale of production
Output
Long-run ATC
Smaller firms Larger firms
Average total cost Short-run ATCs faced by firms
of varying sizes
Summary
decision‐making process, including how much
to produce and whether to stay in business.
revenues.
between inputs, outputs, and costs by studying
a firm’s profitability.
Summary
• Fixed costs are those that don’t depend on the
quantity of output produced.
• Variable costs are those that do depend on the
quantity of output produced.
• Costs include both implicit and explicit costs.
• Firms are able to adjust scale of production over
time.
become variable in the long run
• A firm’s long‐run cost curve reflects the increased
flexibility of fixed costs.