Chapter 8 – Costs and production. Production The total amount of output produced by a firm is a function of the levels of input usage by the firm The.

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 fixed costs – costs that do not vary with the level of output. Fixed costs are the same at all levels of output (even when output equals zero).  variable.

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Presentation transcript:

Chapter 8 – Costs and production

Production The total amount of output produced by a firm is a function of the levels of input usage by the firm The total amount of output produced by a firm is a function of the levels of input usage by the firm Total Physical Product (TPP) function - a short-run relationship between the amount of labor and the level of output, ceteris paribus. Total Physical Product (TPP) function - a short-run relationship between the amount of labor and the level of output, ceteris paribus.

Total physical product (TPP)

Law of diminishing returns as the level of a variable input rises in a production process in which other inputs are fixed, output ultimately increases by progressively smaller increments.

Average physical product (APP) APP = TPP / amount of input

Marginal physical product (MPP) the additional output that results from the use of an additional unit of a variable input, holding other inputs constant measured as the ratio of the change in output (TPP) to the change in the quantity of labor (or other input) used

Computation of MPP and APP Note that the MPP is positive when an increase in labor results in an increase in output; a negative MPP occurs when output falls when additional labor is used.

TPP

Shape of MPP curve MPP rises when TPP increases at an increasing rate, and declines when TPP increases at a decreasing rate. MPP is negative if TPP declines when labor use rises

Relationship of APP and MPP APP rises when MPP > APP APP falls when MPP < APP APP is maximized when MPP = APP

Total costs Short run Long run Short run costs: fixed costs – costs that do not vary with the level of output. Fixed costs are the same at all levels of output (even when output equals zero). variable costs – costs that vary with the level of output (= 0 when output is zero)

Example

Example (cont.)

Fixed costs

Variable costs

TC, TVC, and TFC

Average fixed cost Average fixed cost (AFC) = TFC / Q

Average variable cost Average variable cost (AVC) = TVC / Q

Average total cost Average total cost (ATC) = TC / Q ATC = AFC + AVC (since TFC + TVC = TC)

Marginal cost Marginal cost (MC) = cost of an additional unit of output

Average fixed cost

AVC, ATC, and MC Note that the MC curve intersects the AVC and ATC at their respective minimum points

Long-run costs In the long run, a firm may choose its level of capital, and will select a size of firm that provides the lowest level of ATC.

Economies and diseconomies of scale Economies of scale – factors that lower average cost as the size of the firm rises in the long run Sources: specialization and division of labor, indivisibilities of capital, etc. Diseconomies of scale – factors that raise average cost as the size of the firm rises in the long run Sources: increased cost of managing and coordination as firm size rises Constant returns to scale – average costs do not change as firm size changes

Long-run average total cost (LRATC)

Minimum efficient scale Minimum efficient scale = lowest level of output at which LRATC is minimized