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Harcourt Brace & Company THE COSTS OF PRODUCTION Chapter 13.

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Presentation on theme: "Harcourt Brace & Company THE COSTS OF PRODUCTION Chapter 13."— Presentation transcript:

1 Harcourt Brace & Company THE COSTS OF PRODUCTION Chapter 13

2 Harcourt Brace & Company The Costs of Production n The Law of Supply ä Firms are willing to produce and sell a greater quantity of a good when the price of the good is high. ä This results in a supply curve that slopes upward.

3 Harcourt Brace & Company The Firm’s Objective n The economic goal of the firm is to maximize profits.

4 Harcourt Brace & Company A Firm’s Total Revenue and Total Cost n Total Revenue ä The amount that the firm receives for the sale of its product. n Total Cost ä The amount that the firm pays to buy inputs.

5 Harcourt Brace & Company A Firm’s Profit n Profit is often referred to as producer surplus. n It is the amount a seller is paid minus costs. Profit = Total revenue - Total cost

6 Harcourt Brace & Company Costs as Opportunity Costs n A firm’s costs of production include all the opportunity costs of making its output of goods and services.

7 Harcourt Brace & Company Explicit and Implicit Costs n A firm’s cost of production include explicit costs and implicit costs. ä Explicit costs involve a direct money outlay for factors of production. ä Implicit costs do not involve a direct money outlay.

8 Harcourt Brace & Company Economic Profit versus Accounting Profit n Economists include all opportunity costs when measuring costs. n Accountants measure the explicit costs but often ignore the implicit costs.

9 Harcourt Brace & Company Economic Profit versus Accounting Profit n When total revenue exceeds both explicit and implicit costs, the firm earns economic profit. ä Economic profit is smaller than accounting profit.

10 Harcourt Brace & Company Economic Profit versus Accounting Profit Revenue Total opportunity costs How an Economist Views a Firm Explicit costs Economic profit Implicit costs

11 Harcourt Brace & Company Economic Profit versus Accounting Profit Revenue Total opportunity costs How an Economist Views a Firm Explicit costs Economic profit Implicit costs Explicit costs Accounting profit How an Accountant Views a Firm Revenue

12 Harcourt Brace & Company Production and Costs n A firm’s costs reflect its production process.

13 Harcourt Brace & Company The Production Function n The production function shows the relationship between quantity of inputs used to make a good and the quantity of output of that good.

14 Harcourt Brace & Company Marginal Product n The marginal product of any input into production is the increase in the quantity of output obtained from an additional unit of that input.

15 Harcourt Brace & Company Marginal Product n The marginal product of any input into production is the increase in the quantity of output obtained from an additional unit of that input.

16 Harcourt Brace & Company Diminishing Marginal Product n Diminishing marginal product is the property whereby the marginal product of an input declines as the quantity of the input increases. ä Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment.

17 Harcourt Brace & Company Diminishing Marginal Product n The slope of the production function measures the marginal product of an input, such as a worker. n When the marginal product declines, the production function becomes flatter.

18 A Production Function Quantity of Output (cookies per hour) Number of Workers Hired Production function

19 Harcourt Brace & Company Production Function and Total Costs n The relationship between the quantity a firm can produce and its costs determines its pricing decisions. n The total-cost curve shows this relationship graphically.

20 Harcourt Brace & Company A Production Function and Total Cost Number of Workers Output (Quantity) Marginal Product of Labor Cost of Factory Cost of Workers Total Cost of Inputs 00$30$0$

21 Total-Cost Curve Total Cost $ Quantity of Output (cookies per hour) Total-cost curve

22 Harcourt Brace & Company The Various Measures of Cost n Costs of production may be divided into fixed costs and variable costs.

23 Harcourt Brace & Company The Various Measures of Cost n Fixed costs are those costs that do not vary with the quantity of output produced.

24 Harcourt Brace & Company The Various Measures of Cost n Variable costs are those costs that do vary with the quantity of output produced.

25 Harcourt Brace & Company Family of Total Costs n Total Fixed Costs (TFC) n Total Variable Costs (TVC) n Total Costs (TC) TC = TFC + TVC

26 Family of Total Costs

27 Harcourt Brace & Company Average Costs n Average costs can be determined by dividing the firm’s costs by the quantity of output produced. n The average cost is the typical cost of each unit of product.

28 Harcourt Brace & Company Family of Average Costs n Average Fixed Costs (AFC) n Average Variable Costs (AVC) n Average Total Costs (ATC)

29 Harcourt Brace & Company Family of Average Costs

30 Harcourt Brace & Company Table 13-3 Various Measures of Cost: Big Bob’s Bagel Bin

31 Family of Average Costs

32 Harcourt Brace & Company Marginal Cost n Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production. Marginal cost helps answer the following question: ä How much does it cost to produce an additional unit of output?

33 Harcourt Brace & Company Marginal Cost

34 Harcourt Brace & Company Marginal Cost

35 Harcourt Brace & Company Quick Quiz! n Ford’s total cost of producing 4 cars is $225,000 and its total cost of producing 5 cars is $250,000.

36 Harcourt Brace & Company Quick Quiz! n What is the average total cost and marginal cost of producing the fifth car?

37 Harcourt Brace & Company Cost Curves and Their Shapes n Marginal cost rises with the amount of output produced. ä At low levels of output, an increase in production will occur at a relatively small cost. ä Increasing output is more costly when the amount being produced is already high.

38 Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $

39 Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $ MC

40 Harcourt Brace & Company Cost Curves and Their Shapes n The average total-cost curve is U- shaped. ä At very low levels of output average total cost is high because fixed cost is spread over only a few units. ä Average total cost declines as output increases. ä Average total cost starts rising because average variable cost rises substantially.

41 Harcourt Brace & Company Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $

42 Harcourt Brace & Company Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $ ATC AVC AFC

43 Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost n Whenever marginal cost is less than average total cost, average total cost is falling. n Whenever marginal cost is greater than average total cost, average total cost is rising.

44 Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost n The marginal-cost curve crosses the average-total-cost curve at the efficient scale. ä Efficient scale is the quantity that minimizes average total cost.

45 Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost Quantity of Output (bagels per hour) Costs $

46 Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost Quantity of Output (bagels per hour) Costs $ ATC

47 Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost Quantity of Output (bagels per hour) Costs $ MC ATC

48 Harcourt Brace & Company Costs in the Long Run n For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered. ä In the short run some costs are fixed. ä In the long run fixed costs become variable costs.

49 Harcourt Brace & Company Costs in the Long Run n Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.

50 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost n Economies of scale occur when long- run average total cost falls as the quantity of output increases.

51 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost n Diseconomies of scale occur when long-run average total cost rises as the quantity of output increases.

52 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost n Constant returns to scale occur when long-run average total cost stays the same as the quantity of output increases.

53 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost

54 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory

55 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory ATC in short run with medium factory

56 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory

57 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost

58 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in long run

59 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost Economies of scale ATC in long run

60 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost Economies of scale ATC in long run Constant returns to scale

61 Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost Economies of scale ATC in long run Diseconomies of scale Constant returns to scale

62 Harcourt Brace & Company Quick Quiz! n When Boeing produces 9 jets per month, its long-run total cost is $9.0 million per month.

63 Harcourt Brace & Company Quick Quiz! n When Boeing produces 10 jets per month, its long-run total cost is $9.5 million per month.

64 Harcourt Brace & Company Quick Quiz! n Does Boeing exhibit economies or diseconomies of scale?

65 Harcourt Brace & Company Conclusion n The goal of firms is to maximize profit, which equals total revenue minus total cost. n Some costs are explicit. Other costs, such as opportunity costs, are implicit. n A firm has fixed and variable costs. Fixed costs don’t vary with quantities produced; variable costs do.

66 Harcourt Brace & Company Conclusion n Average total cost is total cost divided by the quantity of output. n Marginal cost is the amount total cost rises if output is increased by one unit. n Marginal cost generally rises with the quantity of output; average total cost first falls as output increases and then eventually rises with further output.

67 Harcourt Brace & Company Conclusion n A firm’s costs often depend on the time horizon being considered. n Many costs are fixed in the short run but variable in the long run. n When the level of production changes, average total cost may rise more in the short run than in the long run.

68 Harcourt Brace & Company THE COSTS OF PRODUCTION End of Chapter 13


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