October 21, 2013

1. October 21, 2013 • Review Unit II Exam • Begin Unit III- Theory of the Firm (Chapters 7-11)-Exam 11/21 & 11/22 • Start Chapter 7??? • Chapter 7 Quiz: Friday 10/25

2. Chapter 7: Businesses and the Costs of Production We go from the behavior of the consumer to the behavior of the producer…

3. Economic Costs • Firms face costs: They need scarce resources that have alternative uses to make their products. • Economic Costs: The payment that must be made to obtain and retain the services of a resource. • All resources used by a firm have an opportunity cost. • Explicit Costs: Monetary payments (O.C) it makes to buy resources. (Obvious) • Implicit Costs: Monetary costs of using resources it already owns (present but not obvious.) • E-Costs= E.C. + I.C • OK, an example… 7-3 LO1

4. Accounting Profit, Normal Profit, Economic 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 7-4 LO1

5. Economic Profit Economic profit Accounting profit Implicit costs (including a normal profit) Total Revenue Accounting costs (explicit costs only) Economic (Opportunity) Costs Explicit costs 7-5 LO1

6. Short Run and Long Run • Short Run • Some variable inputs • Fixed plant • Long Run • All inputs are variable • Variable plant • Firms enter and exit 7-6 LO1

7. The Law of Diminishing Returns 7-7 LO2

8. The Law of Diminishing Returns 75 TP 50 Total Product, TP 25 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 7-8 LO2

9. October 23, 2013 • Recap past 2 days… • Continue Chapter 7 Notes • Reminder: Ch. 7 Quiz Friday • HW: Chapter 7 Question #7 Stay after for extra help with yesterday’s content if necessary…

10. Recap From Past 2 Days: Ch.7 • Economic Costs • Explicit Costs • Implicit Costs • Accounting Profit • = Total Revenue – Explicit Costs. • Economic Profit (Normal Profit) • Total Revenue – Explicit and Implicit Costs • Short Run & Long Run • Short Run Production- • Total Product- total output of good or service • Marginal Product: Change in TP / Change in Input of Labor • Average Product: (Labor Productivity) : TP / Units of Labor • Law of Diminishing Returns (adding a variable to fixed capital)

11. Short-Run Production Costs • Fixed Costs (TFC): Costs that do not vary with output (incurred at all levels of output!) • i.e.: Rent, Interest on loans, depreciation, insurance, fixed bills. • Variable Costs (TVC): Costs that change with varying levels of output. • i.e: Materials, transportation, labor • Total Costs (TC): Sum of TFC and TVC at each output. • TC = TFC + TVC 7-11 LO3

12. 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 7-12 LO3

13. LO3

14. $1100 1000 900 800 700 600 Costs 500 400 300 200 100 0 10 1 2 3 4 5 6 7 8 9 Q Short-Run Production Costs TC TVC Fixed Cost Total Cost Variable Cost TFC 7-14 LO3

15. $200 150 100 Costs 50 0 10 1 2 3 4 5 6 7 8 9 Q Per-Unit, or Average, Costs ATC AVC AFC AVC AFC 7-15 LO3

16. $200 150 100 Costs 50 0 10 1 2 3 4 5 6 7 8 9 Q Marginal Cost MC ATC AVC AFC AVC AFC 7-16 LO3

17. Average Product and Marginal Product Cost (Dollars) MC and MP Production Curves As long as MP is rising, MC will fall! Then the 4th worker… MC and MP are mirror images AP MP 4 Quantity of Labor MC AVC Cost Curves Quantity of Output 7-17 LO3

18. Long-Run Production Costs • The firm can change all input amounts, including plant size, for desired outcome. • All costs are variable in the long run. • So all we care about is ATC… • Go to page 153… • Expand to a new plant if cost per unit will be less! • Long-Run ATC curve: Lowest ATC at which any output level can be produced • Blue bumpy curve is Long Run ATC curve! 7-18 LO4

19. Firm Size and Costs ATC-1 ATC-5 ATC-2 ATC-4 ATC-3 Average Total Costs Output 7-19 LO4

20. The Long-Run Cost Curvea.k.a. Planning Curve The Choice of Plant Sized is usually much wider… ATC-1 ATC-5 ATC-2 Long-run ATC Points of Tangency = smooth ATC-4 ATC-3 Average Total Costs Output Each point tells minimum ATC of producing corresponding level of output! 7-20 LO4

21. Economies and Diseconomies of Scale • Law of Diminishing Returns does not apply to Long-Run production!!! • So why the U-Shape Long-Run curve? • Economies of scale (economies of mass production- explains down-slopingpart-lower per-unit costs) • Labor specialization (Specific tasks, shifts, etc.) • Managerial specialization (Better use of managerial skills) • Efficient capital (larger the firms and plants, better equipment) • Other factors (less start-up costs, advertising, etc.) 7-21 LO4

22. Economies and Diseconomies of Scale • Diseconomies of scale (over time production costs per unit higher…) • Bureaucracy/Communication problems • Worker Alienation • Shirking  • Constant Returns To Scale (In between the up and down- ATC is constant) 7-22 LO4

23. Economies of Scale rapidly obtained, diseconomies of scale not encountered Until large number of output achieved ATC is constant for a while… Diseconomies Of Scale Constant Returns To Scale Economies Of Scale Average Total Costs Long-run ATC q1 q2 Output 7-23 LO4

24. MES and Industry Structure • Minimum Efficient Scale (MES): • Lowest level of output where long- run average costs are minimized • Economies of Scale are exhausted; diseconomies of scale have not yet kicked in! 7-24 LO4

25. Economies of Scale extensive; diseconomies of scale occur at high output level ATC declines over broad range.. Economies Of Scale Diseconomies Of Scale Average Total Costs Long-run ATC Output 7-25 LO4

26. Economies of Scale exhausted quickly, followed by Immediate diseconomies of scale. Minimum ATC occurs at very low output. Diseconomies Of Scale Economies Of Scale Long-run ATC Average Total Costs Output 7-26 LO4