CHAPTER 6 THE ORGANIZATION AND COSTS OF PRODUCTION

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Presentation transcript:

CHAPTER 6 THE ORGANIZATION AND COSTS OF PRODUCTION Part Two: Microeconomics of Product Markets CHAPTER 6 THE ORGANIZATION AND COSTS OF PRODUCTION

In this chapter you will learn: 6.1 The various organizational forms a firm can take 6.2 What are economic costs 6.3 About a firm’s short-run production relationships 6.4 About a firm’s short-run production costs 6.5 The link between a firm’s size and costs in the long run ©2007 McGraw-Hill Ryerson Ltd. Chapter 6

The Firm and the Business Sector Different organizational structures: Plant Firm Industry Horizontal combinations Vertical combinations Conglomerates Plant=factory ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.1

The Firm and the Business Sector Legal Forms of Businesses: Sole Proprietorship Partnership Corporation Advantages of Corporations The Principal-Agent Problem Sole proprietorship: dnghiep 1 chu Partnership: hiep hoi The principal agent problem: van de nguoi uy thac ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.1

Economic Costs Opportunity Cost Explicit Costs payments a firm must make Implicit Costs opportunity costs of firm’s own resources include normal profits ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.2

Total (explicit) costs Normal Profit as a Cost Total Revenue $120,000 Cost of T - shirts $40,000 Clerk's salary $18,000 Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000 ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.2

Total (explicit) costs Normal Profit as a Cost Total Revenue $120,000 Cost of T - shirts $40,000 Clerk's salary $18,000 Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000 Forgone interest $ 1,000 Forgone rent $ 5,000 Forgone wages $2 2 ,000 Normal profit Total implicit c osts $ 3 3 Economic profit $ 24,000 ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.2

Economic profit = total revenue – economic cost Normal Profit as a Cost Costs of production include all costs explicit implicit including a normal profit required to attract and retain factors of production Economic profit = total revenue – economic cost ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.2

Figure 6-1 Economic Profit vs. Accounting Profit Profits Accounting Profits Implicit costs (including a normal profit) Total Revenue Economic (opportunity) Costs Accounting costs (explicit costs only) Explicit Costs ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.2

Short Run and Long Run Short Run Long Run Fixed Plant Variable Plant ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

Short-Run Production Relationships Total Product (TP) total quantity produced Marginal Product (MP) change in total product change in labour input = Average Product (AP) total product units of labour = ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.2

Short-Run Production Relationships Law of Diminishing Returns marginal product eventually diminishes ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

Table 6-1 Total, Marginal, and Average Product Units of labour TP MP AP 1 10 2 25 3 45 4 60 5 70 6 75 7 8 change in total product change in labour input MP= ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

Total, Marginal, and Average Product Units of labour TP MP AP 1 10 2 25 3 45 4 60 5 70 6 75 7 8 Increasing marginal returns 10 15 20 Diminishing marginal returns 15 10 5 Negative marginal returns -5 ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

Total, Marginal, and Average Product Units of labour TP MP AP 1 10 2 25 3 45 4 60 5 70 6 75 7 8 total product total labour input AP= 10 10.00 15 12.50 20 15.00 15 15.00 14.00 12.50 10.71 8.75 10 5 -5 ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

negative marginal returns increasing marginal returns diminishing marginal returns TP negative marginal returns AP MP Figure 6-2 ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

Marginal and Average Values If the average value is rising, the marginal value must be ABOVE the average value If the average value is falling, the marginal value must be BELOW the average value ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

Marginal and Average Values Average value falling MP >AP Average value rising AP MP <AP MP ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.3

Fixed, Variable, and Total Costs Fixed Costs do not vary with changes in output Variable Costs change with changes in output Total Cost sum of fixed and variable costs ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Per-Unit, or Average, Costs ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Marginal Cost Marginal cost is the extra, or additional, cost of producing one more unit of output Illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

100 Q TFC TVC TC AFC AVC ATC MC 1 2 3 4 5 6 7 8 9 10 90 170 240 300 1 2 3 4 5 6 7 8 9 10 90 170 240 300 370 450 540 650 780 930 100 100 TC=TFC + TVC 190 270 340 400 470 550 640 750 880 1030 ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Total Cost is the Sum of Fixed Cost and Variable Cost Figure 6-3 TFC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Total Cost is the Sum of Fixed Cost and Variable Cost TC Add vertically to get TC TVC TFC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Q TFC TVC TC AFC AVC ATC MC 100 1 90 2 170 3 240 4 300 5 370 6 450 7 100 1 90 2 170 3 240 4 300 5 370 6 450 7 540 8 650 9 780 10 930 AVC=TVC / Q 100 ATC=TC / Q AFC=TFC / Q 190 100 90 190 270 50 85 135 340 400 470 550 640 750 880 1030 33.33 80 113.33 25 20 16.67 14.29 12.50 11.11 10 75 74 77.14 81.25 86.67 93 100 94 91.67 91.43 93.75 97.78 103 ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Note: MC is graphed at average Q TFC TVC TC AFC AVC ATC MC 100 1 90 2 170 3 240 4 300 5 370 6 450 7 540 8 650 9 780 10 930 MC=TC / Q 100 90 190 100 90 190 80 270 50 85 135 2.5 70 340 400 470 550 640 750 880 1030 33.33 80 113.33 60 70 80 90 110 130 150 25 20 16.67 14.29 12.50 11.11 10 75 74 77.14 81.25 86.67 93 100 94 91.67 91.43 93.75 97.78 103 Note: MC is graphed at average Q ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

AFC, AVC, and ATC Figure 6-5 AFC continually declines as fixed cost is spread over more and more units AFC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

AVC is U-shaped: it starts to rise when AP starts to fall AFC, AVC, and ATC AVC is U-shaped: it starts to rise when AP starts to fall AVC AFC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Get ATC by vertically summing AFC and AVC AFC, AVC, and ATC Get ATC by vertically summing AFC and AVC ATC AVC AFC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

MC cuts ATC and AVC at minimum points MC, AVC, and ATC MC cuts ATC and AVC at minimum points ATC MC AVC AFC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Figure 6-6 Productivity Curves and Cost Curves Average Product and Marginal Product AP MP Labour MC AVC Costs (dollars) Output ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Relation of MC to AVC and ATC When MC < current ATC ATC will fall When MC > current ATC ATC will rise MC intersects ATC and AVC at minimum points ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Shifts of Cost Curves Factor Prices price of fixed input increases... AFC and ATC shift up AVC and MC unchanged price of variable input increases... AVC, ATC, and MC shift up AFC unchanged ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Shifts of Cost Curves Technology improved technology lower costs cost curves shift down curve shifts depend on whether technology affects FC, VC, or both ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.4

Long-Run Production Costs What will costs look like when the firm can choose the best plant size for any given situation? For every plant capacity size, there is a short-run ATC curve All such plant capacities can be plotted... ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Figure 6-7 The Long-Run Average-Total-Cost Curve ATC-4 ATC-3 ATC-1 ATC-2 ATC-5 Choose the best plant for every output level These choices determine the LRATC curve ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Figure 6-8 The Long-Run Average-Total-Cost Curve LRATC The number of possible plant sizes is virtually unlimited The LRATC curve just envelops the short-run cost curves ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Economies of Scale Diseconomies of Scale Constant Returns to Scale Labour Specialization Managerial Specialization Efficient Capital Other Factors Diseconomies of Scale Constant Returns to Scale ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Figure 6-9 Economies and Diseconomies of Scale Constant returns to scale Economies of scale Diseconomies of scale LRATC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Minimum Efficient Scale ATC-4 ATC-3 ATC-1 ATC-2 ATC-5 MES is the smallest level of output that minimizes LRATC ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Minimum Efficient Scale Relatively large MES natural monopoly LRATC MES ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Minimum Efficient Scale LRATC Relatively small MES competitive industry MES ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Applications and Illustrations Successful Startup Firms The Daily Newspaper The Verson Stamping Machine Aircraft and Concrete Plants ©2007 McGraw-Hill Ryerson Ltd. Chapter 6.5

Chapter Summary 6.1 The Firm and the Business Sector 6.2 Economic Costs Opportunity Cost 6.3 Short-Run Production Relationships The Law of Diminishing Return TP, AP and MP 6.4 Short-Run Production Costs Fixed Cost, Average Cost, and Marginal Cost 6.5 Long-Run Production Costs ©2007 McGraw-Hill Ryerson Ltd. Chapter 6