10 Businesses and the Costs of Production McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Includes normal profit Economic Costs The payment that must be made to obtain and retain the services of a resource Explicit Costs Monetary payments Implicit Costs Value of next best use Self-owned resources Includes normal profit 10-2 LO1
Accounting Profit and Normal Profit = Revenue – Explicit Costs Economic profit = Accounting Profit – Implicit Costs Economic profit (to summarize) =Total Revenue – Economic Costs =Total Revenue – Explicit Costs – Implicit Costs 10-3 LO1
Economic Profit Economic profit Accounting profit Implicit costs (including a normal profit) Total Revenue Accounting costs (explicit costs only) (Opportunity) Economic Costs Explicit costs 10-4 LO1
All inputs are variable Variable plant Firms enter and exit Short Run and Long Run Short Run Some variable inputs Fixed plant Long Run All inputs are variable Variable plant Firms enter and exit 10-5 LO1
Short-Run Production Relationships Total Product (TP) Marginal Product (MP) Average Product (AP) Marginal Product Change in Total Product Change in Labor Input = Average Product Total Product Units of Labor = 10-6 LO2
The Law of Diminishing Returns 30 TP Total Product, TP 20 10 1 2 3 4 5 6 7 8 9 Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 20 Marginal Product, MP 10 AP 1 2 3 4 5 6 7 8 9 MP 10-7 LO2
Short-Run Production Costs Fixed Costs (TFC) Costs do not vary with output Variable Costs (TVC) Costs vary with output Total Costs (TC) Sum of TFC and TVC TC = TFC + TVC 10-8 LO3
Short-Run Production Costs 1 2 3 4 5 6 7 8 9 10 Q 100 200 300 400 500 600 700 800 900 1000 $1100 TC TVC Fixed Cost Total Cost Variable Cost TFC 10-9 LO3
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 10-10 LO3
Per-Unit, or Average, Costs 1 2 3 4 5 6 7 8 9 10 Q 50 100 150 $200 ATC AVC AFC AVC AFC 10-11 LO3
Marginal Cost MC ATC Costs AVC AFC AVC AFC Q 1 2 3 4 5 6 7 8 9 10 50 Q 50 100 150 $200 MC ATC AVC AFC AVC AFC 10-12 LO3
MC and Marginal Product Average Product and Marginal Product Cost (Dollars) Production Curves AP MP Quantity of Labor MC AVC Cost Curves Quantity of Output 10-13 LO3
Long-Run Production Costs The firm can change all input amounts, including plant size. All costs are variable in the long run. Long run ATC Different short run ATCs 10-14 LO4
The Long-Run Cost Curve ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Long-Run ATC Average Total Costs Output 10-15 LO4
Economies and Diseconomies of Scale Labor specialization Managerial specialization Efficient capital Other factors Constant returns to scale 10-16 LO4
Economies and Diseconomies of Scale Control and coordination problems Communication problems Worker alienation Shirking 10-17 LO4
MES and Industry Structure Minimum Efficient Scale (MES): Lowest level of output where long- run average costs are minimized Can determine the structure of the industry 10-18 LO4
MES and Industry Structure Economies Of Scale Constant Returns To Scale Diseconomies Of Scale Average Total Costs Long-Run ATC q1 q2 Output 10-19 LO4
Don’t Cry Over Sunk Costs Costs have already been incurred and thus are irrecoverable Rule: Do not engage in any activity where MB<MC Rule: Ignore sunk costs They are irrecoverable 10-20