Presentation is loading. Please wait.

Presentation is loading. Please wait.

Economics by David Begg, Gianluigi Vernasca, Stanley Fischer & Rudiger Dornbusch TENTH EDITION ©McGraw-Hill Companies, 2010 Chapter 7 Costs and supply.

Similar presentations


Presentation on theme: "Economics by David Begg, Gianluigi Vernasca, Stanley Fischer & Rudiger Dornbusch TENTH EDITION ©McGraw-Hill Companies, 2010 Chapter 7 Costs and supply."— Presentation transcript:

1 Economics by David Begg, Gianluigi Vernasca, Stanley Fischer & Rudiger Dornbusch TENTH EDITION ©McGraw-Hill Companies, 2010 Chapter 7 Costs and supply

2 Choosing output Costs Revenues Technology & costs of hiring factors of production TC curves (short & long run) AC (short & long run) MC Demand curve AR MR CHECK: produce in SR? close down in LR? Choose output level ©McGraw-Hill Companies, 2010

3 The production function The amount of output produced depends upon the inputs used in the production process. A factor of production (“input”) is any good or service used to produce output The production function specifies the maximum output which can be produced given inputs ©McGraw-Hill Companies, 2010

4 Short run vs. long run The short run is the period in which a firm can make only partial adjustment of inputs. E.g. the firm may be able to vary the amount of labour, but cannot change capital. The long run is the period in which a firm can adjust all inputs to changed conditions. The long run total cost curve describes the minimum cost of producing each output level when the firm is free to vary all input levels. ©McGraw-Hill Companies, 2010

5 Average cost The average cost of production is total cost divided by the level of output. Long-run average cost (LAC) is often assumed to be U- shaped: Average cost Output ©McGraw-Hill Companies, 2010

6 Economies of scale Economies of scale – or increasing returns to scale – occur when long-run average costs decline as output rises: Average cost Output ©McGraw-Hill Companies, 2010

7 Decreasing returns to scale occur when long-run average costs rise as output rises: Average cost Output ©McGraw-Hill Companies, 2010

8 Constant returns to scale occur when long-run average costs are constant as output rises: Average cost Output ©McGraw-Hill Companies, 2010

9 The firm’s long-run output decision The decision: –If the price is at or above LAC 1 the firm produces Q 1 –If the price is below LAC 1 the firm goes out of business NB: LMC always passes through the minimum point of LAC. £ Output (goods per week) MR LMC = MR ©McGraw-Hill Companies, 2010

10 The short run Fixed factor of production –a factor whose input level cannot be varied Fixed costs –costs that do not vary with output levels Variable costs –costs that do vary with output levels Short-run total cost (STC) = short-run fixed cost (SFC) + short-run variable cost (SVC) ©McGraw-Hill Companies, 2010

11 The marginal product of labour The marginal product of labour is the increase in output obtained by adding 1 unit of the variable factor but holding constant the inputs of all other factors. Labour is often assumed to be the variable factor –with capital fixed. ©McGraw-Hill Companies, 2010

12 The law of diminishing returns Holding all factors constant except one, the law of diminishing returns says that: beyond some value of the variable input further increases in the variable input lead to steadily decreasing marginal product of that input. E.g. trying to increase labour input without also increasing capital will bring diminishing returns. ©McGraw-Hill Companies, 2010

13 The firm’s short-run output decision Firm sets output at Q 1, where SMC=MR subject to checking the average condition: –if price is above SATC 1 firm produces Q 1 at a profit –if price is between SATC 1 and SAVC 1 firm produces Q 1 at a loss –if price is below SAVC 1 firm produces zero output. SAVC 1 £ Output MR Q1Q1 SATC 1 SMC = MR ©McGraw-Hill Companies, 2010

14 The long-run average cost curve LAC Output Average cost SATC 1 Each plant size is designed for a given output level. SATC 2 SATC 3 SATC 4 So there is a sequence of SATC curves, each corresponding to a different plant size. In the long-run, plant size itself is variable, and the long-run average cost curve LAC is found to be the ‘envelope’ of the SATCs. ©McGraw-Hill Companies, 2010

15 The firm’s output decisions – a summary Marginal Condition Check whether to produce Short run decision Long run decision Choose the output at which MR=SMC Choose the output at which MR=LMC Produce this output unless price lower than SAVC, in which case produce zero Produce this output unless price is lower than LAC, in which case produce zero. ©McGraw-Hill Companies, 2010

16 Some maths An example of a short-run total cost function: Where SFC=F and SVC = cQ+ Dq 2 and Thus the short-run average fixed cost decreases steadily as Q increases. ©McGraw-Hill Companies, 2010

17 Some maths (2) Short run average variable cost is: And short run average total cost: ©McGraw-Hill Companies, 2010


Download ppt "Economics by David Begg, Gianluigi Vernasca, Stanley Fischer & Rudiger Dornbusch TENTH EDITION ©McGraw-Hill Companies, 2010 Chapter 7 Costs and supply."

Similar presentations


Ads by Google