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Unit 6 Costs and Decision Making. Role of the Firm Goal  Firms make decisions to maximize profits Production  Transformation of factors into goods Production.

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Presentation on theme: "Unit 6 Costs and Decision Making. Role of the Firm Goal  Firms make decisions to maximize profits Production  Transformation of factors into goods Production."— Presentation transcript:

1 Unit 6 Costs and Decision Making

2 Role of the Firm Goal  Firms make decisions to maximize profits Production  Transformation of factors into goods Production Function  Relationship between the amounts of inputs and quantity of outputs a firm produces  Q = A * fcn(Land, Labor, Capital, Entrepreneurship)

3 Production Decisions Time Frame Short Run (SR)  Time period where at least one input is fixed Long Run (LR)  Time period long enough to where all inputs are variable Very Long Run (VLR)  Allows for technological change to occur

4 Short Run Costs Fixed Costs (FC)  Costs associated with use of fixed inputs (resources used by a firm that remain constant in the SR)  Example: Property tax, Rental payments, etc. Variable Costs (VC)  Costs associated with the use of variable inputs (inputs that increase as the level of production increases)  Example: Raw material costs, hourly wages, etc. Total Costs (TC) = FC + VC Marginal Costs (MC)  Added cost of an additional unit of output  Change in TC / Change in Q

5 Short Run Average Costs Average Fixed Costs (AFC)  AFC = FC / Q Average Variable Costs (AVC)  AVC = VC / Q Average Total Costs (ATC)  ATC = AVC + AFC

6 Observations of Cost Curves AFC continually declines as output expands AVC and ATC decrease at first, then begin to slowly increase  Law of Diminishing Marginal Returns

7 Production Decision Example Simply - a market with only two inputs: Labor and Capital In the Short Run: Capital is fixed Labor is variable Here, the output produced is said to be the product of labor since nothing is produced without workers. Total Product of Labor = total quantity of output produced by the total number of workers. Marginal Product of Labor = additional output (total product) produced from adding an additional worker.

8 Law of Diminishing Returns When additional units of labor are added to a fixed input, the Marginal Product of labor must eventually decrease. Why do you think this occurs?

9 Rib Restaurant Example We have a BBQ Rib Restaurant that hires employees in order to serve dinners to its customers.  Fixed Cost: Restaurant building, ovens, cooking equipment, plates, etc  Variable Cost Workers, dinner ingredients, beverages, etc.

10 Rib Restaurant Example Simplified to only Labor and Capital:  The Fixed Cost of Capital is $100 per hour rent.  The Variable Cost of Labor is $10 an hour per worker. The Total Product is the number of dinners that the restaurant can serve in an hour.

11 Rib Restaurant Example Units of Labor Total Product (Q) 00 13 210 320 427 531 632 730

12 Rib Restaurant Example http://nces.ed.gov/nceskids/createagraph/default.aspx?ID=27f50352402b4e789923ed484822bdb6

13 Rib Restaurant Example Units of Labor Total Product (Q) Marginal Product Average Product 00 13 210 320 427 531 632 730

14 Rib Restaurant Example Units of Labor Total Product (Q) Marginal Product Average Product 00 -- 13 3 210 7 320 10 427 7 531 4 632 1 730 -2

15 Rib Restaurant Example Units of Labor Total Product (Q) Marginal Product Average Product 00 -- 13 3 3 210 7 5 320 10 6.7 427 7 6.75 531 4 6.2 632 1 5.3 730 -2 4.3

16 Rib Restaurant Example

17 Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 13 210 320 427 531 632

18 Rib Restaurant Example Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 100 13 210 100 320 100 427 100 531 100 632 100

19 Rib Restaurant Example Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 1000 13 10 2 10020 3 10030 427 10040 531 10050 632 10060

20 Rib Restaurant Example Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 1000 13 10110 210 10020120 320 10030130 427 10040140 531 10050150 632 10060160

21 Rib Restaurant Example Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 1000 -- 13 1001011033.33 210 1002012010 320 100301305 427 100401403.7 531 100501503.23 632 100601603.13

22 Rib Restaurant Example Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 1000 -- 13 1001011033.333.33 210 10020120102.00 320 1003013051.50 427 100401403.71.48 531 100501503.231.61 632 100601603.131.87

23 Rib Restaurant Example Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 1000 -- 13 1001011033.333.3336.66 210 10020120102.0012.00 320 1003013051.506.50 427 100401403.71.485.18 531 100501503.231.614.84 632 100601603.131.875.00

24 Rib Restaurant Example Units of Labor TPFC / hour VC / hour TC / hour AFC / hour AVC / hour ATC / hour MC / hour 00 1000 -- 13 1001011033.333.3336.663.33 210 10020120102.0012.001.43 320 1003013051.506.501.00 427 100401403.71.485.181.43 531 100501503.231.614.842.50 632 100601603.131.875.0010.00

25 Rib Restaurant Example

26 http://nces.ed.gov/nceskids/createagraph/default.aspx?ID=27f50352402b4e789923ed484822 bdb6

27 Typical Short Run Cost Curves

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