Businesses and Their Costs

1. Businesses and Their Costs 6

2. The Business Population • Plant • Factory, farm, mine, store, website, warehouse • Firm • Operates one or more plants • Industry • Group of firms that produce the same products LO1

3. Corporation Advantages • Stocks • Ownership shares of a corporation • Bonds • Liabilities of a corporation • Limited liability LO1

4. Principal-Agent Problem • Principals • Stockholders • Agents • Executives LO1

5. Economic Costs The payment that must be made to obtain and retain the services of a resource Explicit costs Monetary payments Implicit costs Value of next best use Self-owned resources Includes normal profit LO2

6. Accounting Profit and Normal Profit Accounting profit = Revenue – Explicit costs Economic profit = Accounting profit – Implicit costs Economic profit (to summarize) = Total revenue – Economic costs = Total revenue – Explicit costs – Implicit Costs LO2

7. Economic Profit Economic profit Accounting profit Implicit costs (including a normal profit) Total Revenue Economic (Opportunity) Costs Explicit costs Accounting costs (explicit costs only) LO2

8. Short Run and Long Run Short run Some variable inputs Fixed plant Long run All inputs are variable Variable plant Firms enter and exit LO3

9. Short-Run Production Relationships Total product (TP) Marginal product (MP) Average product (AP) Change in total product = Marginal product Change in labor input Total product = Average product Units of labor LO3

10. Law of Diminishing Returns Resources are of equal quality Technology is fixed Variable resources are added to fixed resources At some point, marginal product will fall Rationale LO3

11. The Law of Diminishing Returns LO3

12. The Law of Diminishing Returns 30 TP 20 Total Product, TP 10 0 1 2 3 4 5 6 7 8 9 Increasing Marginal Returns Negative Marginal Returns Diminishing Marginal Returns 20 Marginal Product, MP 10 AP 1 2 3 4 5 6 7 8 9 MP LO3

13. Short-Run Production Costs Fixed costs (TFC) Costs do not vary with output Variable costs (TVC) Costs vary with output Total costs (TC) Sum of TFC and TVC TC = TFC + TVC LO4

14. Per-Unit, or Average, Costs Average fixed costs AFC = TFC/Q Average variable costs AVC = TVC/Q Average total costs ATC = TC/Q Marginal costs MC = ΔTC/ΔQ LO4

15. Short-Run Production Costs LO4

16. Marginal Cost $200 150 100 Costs 50 0 10 1 2 3 4 5 6 7 8 9 Q MC AFC ATC AVC AVC AFC LO4

17. Long-Run Production Costs The firm can change all input amounts, including plant size All costs are variable in the long run Long-run ATC Different short-run ATCs LO5

18. Firm Size and Costs ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Average Total Costs Output LO5

19. The Long-Run Cost Curve ATC-1 ATC-5 ATC-2 Long-run ATC ATC-4 ATC-3 Average Total Costs Output LO4

20. Economies and Diseconomies of Scale Economies of scale Labor specialization Managerial specialization Efficient capital Other factors Constant returns to scale LO5

21. Economies and Diseconomies of Scale Diseconomies of scale Control and coordination problems Communication problems Worker alienation Shirking LO5

22. 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 LO5

23. MES and Industry Structure Diseconomies of Scale Constant Returns to Scale Economies of Scale Average Total Costs Long-run ATC q1 q2 Output LO5

24. MES and Industry Structure Economies of Scale Diseconomies of Scale Average Total Costs Long-run ATC Output LO5

25. MES and Industry Structure Diseconomies of Scale Economies of Scale Average Total Costs Long-run ATC Output LO5