Chapter 20: Costs of Production / The Short-Run & The Long-Run

1. Chapter 20: Costs of Production / The Short-Run & The Long-Run Principles of MicroEconomics: Econ102

2. The Short-Run / The Long-Run……… does not refer to a specific period of time, but rather are general or broad periods of time that coexist!! Short-Run: The period of time during which at least one of the firm’s inputs is fixed. Long-Run: A period of time long enough to allow a firm to vary all of its inputs, to adopt new technology, and to increase or decrease the size of its physical plant.

3. Accounting Costs versus Economic Costs Total Accounting Costs =Explicit costs only Versus Total Economic Costs =Explicit + Implicit costs Where……… Explicit Costs: Thosepaid to factors of production owned by people outside of the business (tangible, monetary costs) Implicit Costs: Represent the opportunity costs of the owner(s), primarily intangible costs…..sacrifices….what is given up

4. Accounting Profits versus Economic Profits Economic Profit: Total revenue (TR) minus total economic costs (TEC) Versus Accounting Profit: Totalrevenue (TR) minus total accounting costs (TAC) Where……. Total Revenue = Price multiplied by quantity/output (PxQ)

5. Fixed Costs versus Variable Costs Fixed costs: Costs that remain constant (don’t change) as output changes. Variable costs: Costs that change as output changes. Total cost: The cost of all the inputs a firm uses in production. Total Cost = Fixed Cost + Variable Cost TC = FC + VC

6. Average Fixed Costs versus Average Variable Costs Average Fixed Costs (AFC): Fixed costs divided by the quantity of output produced: AFC = FC/Q Average Variable Costs (AVC): Variable costs divided by the quantity of output produced: AVC = VC/Q Average Total Costs (ATC): Total costs divided by the quantity of output produced: ATC = AFC+AVC or TC/Q

7. Marginal Product of Labor (MPL) or Marginal Physical Product…….. ……..is the additional output a firm produces as a result of hiring one more worker. and determined by how much total output increases as each additional worker is hired.

8. In the Short-Run, the Increase in Output Does not Occur at a Constant Rate….. ………because the Law of Diminishing Marginal Returns states that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable to decline.

9. Marginal Cost Marginal Cost: The change or additional cost to a firm’s total cost from producing one more unit of a good or service.

10. The Production Function ……is the relationship between the inputs employed by the firm and the maximum output it can produce with those inputs In-Class Assignment

11. MC Curve ATC Curve AVC Curve AFC Curve Graphing Cost Curves 2.00 1.80 1.60 1.40 1.20 Costs per Unit 1.00 0.80 0.60 0.40 0.20 0.00 8 17 27 32 36 39 Output/Quantity of Consultations Produced

12. Why are the Marginal and Average Cost Curves U-Shaped? Because: When the marginal product of labor (MPL) is rising, the marginal cost (MC) of output will be falling. When the marginal product of labor is falling, the marginal cost of production will be rising. Or The marginal cost of production falls and then rises – a U-shape – because the marginal product of labor rises and then falls. Or When marginal cost is below average total cost (ATC), average total cost will fall. When marginal cost is above ATC, average total cost will rise. Marginal cost will equal ATC when average total cost is at its lowest point.

13. In Summary: What You Should Know • The marginal cost (MC), average total cost (ATC), and average variable cost (AVC) curves are all U-shaped, and the marginal cost curve intersects the AVC and ATC curves at their minimum points. When marginal cost is less than either AVC or ATC, it causes them to decrease. When MC is above AVC or ATC, it causes them to increase. Therefore, when MC equals AVC or ATC, they must be at their minimum points. • As output increases, average fixed cost (AFC) gets smaller and smaller, because in calculating AFC we are dividing something that gets larger and larger – output – into something that remains constant – fixed cost. Otherwise known as spreading the overhead. • As output increases, the difference between ATC and AVC decreases because the difference between ATC and AVC is AFC, which gets smaller as output increases.

14. Costs in The Long-Run Long-Run Average Total Cost: The cost to produce each unit of a product given that the company can choose the size of plant that is best for that quantity. Long-Run Average Total Cost Curve (LRAC): A curve showing the lowest cost at which the firm is able to produce a given quantity of output in the long run, when no inputs are fixed.

15. Costs in The Long-Run • Economies of Scale: • Exist when a firm’s long-run average costs fall as it increases output. The law of diminishing marginal returns does not apply in the long-run. • Specialization • Large Machinery • Learning Curve / Learn by Doing • Dynamic increasing returns to scale

16. Costs in The Long-Run • Diseconomies of Scale: • Exist when a firm becomes large and its long-run average costs rise as it increases output. • Transportation costs • Principal-agent problem • Shirking • Bureaucracy – hierarchy • Different processes – different specialists • Constant Returns to Scale: • Constant returns to scale exist when a firm’s long-run average costs remain unchanged as it increases output. • Minimum Efficient Scale: • The level of output at which all economies of scale have been exhausted.

17. The Four Market Structures