Lecture 5 & 6 Capital Stocks and Production Costs

The nature of capital stocks Capital stock A quantity of any resource that is valued for its potential economic contributions Investment Actions taken to increase the quantity or quality of a resource now, in order to make benefits possible in the future Stock Something whose quantity can be measured at a point in time Flow Something whose quantity can be measured only over a period of time

Stocks vs. flows

Five forms of capital Natural capital Physical assets provided by nature Manufactured capital All physical assets that have been made by people Financial capital Funds of purchasing power available to facilitate economic activity Human capital People’s capacity for labor and their individual knowledge and skills Social capital The stock of trust, mutual understanding, shared values, and socially held knowledge that facilitates the social coordination of economic activity

Production process: A few definitons Inputs: resources that go into production Outputs: the results of production Waste products: outputs that are not used either for consumption or in a further production process Production: transformation of resources or commodities into things that will ultimately be useful for consumers Final goods: goods that are ready for use by people Intermediate goods: goods that will undergo further processing before they are ready for use

Production costs Accounting cost: the costs of a project, figured in terms of monetary flows Economic costs: the costs of a project, including opportunity costs

Production costs Transaction costs Costs of arranging economic activities Technically efficient The quality of a production process if no other process exists that can produce the same output with smaller quantities of some input(s) Economic efficiency An efficient process involves no unnecessary waste or expense Social costs of production The costs of a project, both those born by the economic actors involved and those borne by the others, figured in terms of opportunity costs

Production function

Production function Fixed input An input to the production that is fixed in quantity, no matter what the level of production Variable input An input to production the quantity of which can be quickly changed, resulting in changes in the level of production Short-run (for production processes) A time period in which at least one input to the production cannot be varied in quantity Long-run (for production processes) A time period in which all inputs to production can be varied in quantity

Graphing the relationship between an input and an output Total product curve A curve showing the total amount of output that can be produced when the quantity of one input is varied (other inputs are held fixed)

Production in the short-run Marginal return: The additional quantity of output gained by using an additional unit of a variable input (with all other inputs held fixed) Diminishing marginal returns: The use of an additional unit of a variable input produces a lesser additional quantity of output than did the previous unit of the input

Production in the short-run

Diminishing marginal returns: The use of an additional unit of a variable input produces a lesser additional quantity of output than did the previous unit of the input Constant marginal returns: The use of an additional unit of a variable input produces the same quantity of additional output as the previous unit of the input Increasing marginal returns: The use of an additional unit of a variable input produces a greater quantity of additional output than did the previous unit of the input

Production in the short-run

Costs in the short-run Fixed cost: the cost associated with using fixed inputs, which is the same no matter what quantity of output is produced Variable cost: the cost associated with using variable inputs, which rises with the quantity of output Total cost: The sum of fixed cost and variable cost Marginal cost: The cost associated with producing the last unit of output

Costs in the short-run Total cost curve: a curve showing the total cost associated with producing various levels of output

Costs in the short-run

Constant marginal cost: The cost of producing an additional unit of output stays the same as more output is produced Decreasing marginal cost: The cost of producing an additional unit of output falls as more output is produced Increasing marginal cost: The cost of producing an additional unit of output rises as more output is produced

Production and costs in the long-run Average cost (or average total cost) Cost per unit of output, computed as the total cost divided by the quantity of output produced Long-run average cost The cost of production, per unit of output when all inputs can be varied in quantity

Production and costs in the long-run

A formal model of producer costs Assumptions: –The only producer is the firm –The firm produces only one good, hair dryers –The firm has already decided on a scale of production and made its choice of Technologies (so, we focus only on its costs in the short-run) –There are no nonmonetary opportunity costs or externalities –We have perfect information about the cost structure of the firm –The firm’s production technology is characterized by diminishing returns to its variable inputs

A formal model of producer costs