1. Chapter 23: The Firm - Cost and Output Determination
ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 23: The Firm - Cost and Output Determination
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2. Short Run versus Long Run
A time period when at least one input, such as plant size, cannot be changed
Plant Size
The physical size of the factories that a firm owns and operates to produce its output
Long Run
The time period in which all factors of production can be varied

3. Short Run versus Long Run
Short run and long run are terms that apply to planning decisions made by managers. The firm always operates in the short run in the sense that decisions can only be made in the present.
But some of these decisions result in a long-term commitment of resources.

4. The Relationship Between Output and Inputs (Short Run)
Production
Any activity that results in the conversion of resources into products that can be used in consumption or inputs to further production
Production Function
The relationship between inputs and output
A technological, not an economic, relationship
The relationship between inputs and maximum physical output

5. Diminishing Marginal Returns
Law of Diminishing (Marginal) Returns
The observation that after some point, successive equal-sized increases in a variable factor of production, such as labor, added to fixed factors of production, will result in smaller increases in output

6. The Relationship Between Output and Inputs
Average Physical Product
Total product divided by the variable input
Marginal Physical Product
The physical output that is due to the addition of one more unit of a variable factor of production
The change in total product occurring when a variable input is increased and all other inputs are held constant
Also called marginal product or marginal return

7. Diminishing Returns, the Production Function, and Marginal Product: A Hypothetical Case
Figure 23-1, Panel (a)

8. Diminishing Returns, the Production Function, and Marginal Product: A Hypothetical Case
Graphical relationship between marginal physical product and total output

9. A B
A – Point of Diminishing Marginal Returns
B – Point of Diminishing Total Returns

10. Short-Run Costs to the Firm
Total Costs
The sum of total fixed costs and total variable costs
Fixed Costs
Costs that do not vary with output
Variable Costs
Costs that vary with the rate of production
Total costs (TC) = TFC + TVC

11. Short-Run Costs to the Firm
Average Total Costs (ATC)
Average total costs (ATC) =
total costs (TC)
output (Q)

12. Short-Run Costs to the Firm
Average total costs (ATC) =
total costs (TC)
output (Q)
Average variable costs (AVC) =
total variable costs (TVC)
output (Q)
Average fixed costs (AFC) =
total fixed costs (TFC)
output (Q)
Marginal costs (MC) =
change in total cost
change in output

13. Cost of Production: An Example
Figure 23-2, Panel (a)

14. Total Cost of Production: An Example
Panel (b) 60
Total costs 50
Total variable
costs 40
Total costs (dollars per day) 30 20 10
Total fixed
costs 1 2 3 4 5 6 7 8 9 10 11
Output (recordable DVDs per day)
Figure 23-2, Panel (b)

15. Average and Marginal Costs of Production: An Example
Figure 23-2, Panel (c)

16. Short-Run Costs to the Firm
As long as marginal physical product rises, marginal cost will fall, and when marginal physical product starts to fall (after reaching the point of diminishing marginal returns), marginal cost will begin to rise.
Inefficient to Efficient to Inefficient

17. The Relationship Between Returns and Average and Marginal Costs
If the wage rate is constant, then the marginal labor cost associated with each additional unit of output will decline as long as the marginal physical product of labor increases.
When marginal cost is less than average variable cost, then average variable cost will decline. When marginal cost exceeds average variable cost, then average variable cost will increase.
It is also true that the direction of change in average total cost will be determined by whether marginal cost exceeds the current average.

18. The Relationship Between Diminishing Marginal Returns and Cost Curves

20. The Marginal and Average Cost Curves
Adding the average fixed cost curve to the graph..
Then,
ATC = AVC + AFC
ATC (SAC)
AFC

21. Long-Run Cost Curves Planning Horizon
The long run, during which all inputs are variable

22. Preferable Plant Size and the Long-Run Average Cost Curve
Panel (a)
Panel (b)
SAC 8 1
SAC
SAC 7 1
SAC 2
SAC 6
SAC C 2
SAC 2 3
SAC C 5
SAC 4 C
SAC 3 4
SAC 1
Average Cost (dollars per unit of output)
Average Cost (dollars per unit of output)
LAC C 3 Q 1 Q 2
Output per Time Period
Output per Time Period
Figure 23-4, Panels (a) and (b)

23. Long-Run Cost Curves Long-Run Average Cost Curve Observation
The locus of points representing the minimum unit cost of producing any given rate of output, given current technology and resource prices
Observation
Only at the minimum of the long-run average cost curve is the minimum of the short-run average cost curve tangent to it.

24. Why the Long-Run Average Cost Curve is U-Shaped
Economies of Scale
Decreases in long-run average costs resulting from increases in output
These economies of scale do not persist indefinitely, however.
Once long-run average costs rise, the curve begins to slope upwards.

25. Why the Long-Run Average Cost Curve is U-Shaped
Reasons for economies of scale
Specialization
Dimensional factor
Improved productive equipment

26. Why the Long-Run Average Cost Curve is U-Shaped
Explaining Diseconomies of Scale
Limits to the efficient functioning of management
Coordination and communication is more of a challenge as firm size increases

27. Minimum Efficient Scale
Minimum Efficient Scale (MES)
The lowest rate of output per unit time at which long-run average costs for a particular firm are at a minimum

28. Minimum Efficient Scale
LAC
Long-Run Average Costs
(dollars per unit) A 10 B
1,000
Output per Time Period
Figure 23-6

29. Minimum Efficient Scale
Small MES relative to industry demand:
There is room for many efficient firms
High degree of competition
Large MES relative to industry demand:
Room for only a small number of efficient firms
Small degree of competition

30. Chapter 23: The Firm - Cost and Output Determination
ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 23: The Firm - Cost and Output Determination
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.