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Slides prepared by Dr. Amy Peng, Ryerson University CHAPTER 6 THE ORGANIZATION AND COSTS OF PRODUCTION Part Two: Microeconomics of Product Markets.

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Presentation on theme: "Slides prepared by Dr. Amy Peng, Ryerson University CHAPTER 6 THE ORGANIZATION AND COSTS OF PRODUCTION Part Two: Microeconomics of Product Markets."— Presentation transcript:

1 Slides prepared by Dr. Amy Peng, Ryerson University CHAPTER 6 THE ORGANIZATION AND COSTS OF PRODUCTION Part Two: Microeconomics of Product Markets

2 ©2007 McGraw-Hill Ryerson Ltd.Chapter 62 In this chapter you will learn: 6.1 The various organizational forms a firm can take 6.2 What economic costs are 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

3 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.13 The Firm and the Business Sector Different organizational structures: 1.Plant 2.Firm 3.Industry Horizontal combinations Horizontal combinations Vertical combinations Vertical combinations Conglomerates Conglomerates

4 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.14 The Firm and the Business Sector Legal Forms of Businesses: 1.Sole Proprietorship 2.Partnership 3.Corporation Advantages of Corporations The Principal-Agent Problem

5 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.25 Opportunity Cost Explicit Costs payments a firm must make Implicit Costs opportunity costs of firm’s own resources include normal profits Economic Costs

6 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.26 Total Revenue $120,000 Cost of T -shirts $40,000 Clerk's salary $18,000 Utilities Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000 Normal Profit as a Cost

7 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.27 Total Revenue $120,000 Cost of T -shirts $40,000 Clerk's salary $18,000 Utilities Utilities $ 5,000 Total (explicit) costs $ 63,000 Accounting Profit $ 57,000 Normal Profit as a Cost Forgone interest $ 1,000 Forgone rent $ 5,000 Forgone wages $22,000 Normal profit $ 5,000 Totalimplicitcosts $ 3 3,000 Economic profit $ 24,000

8 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.28 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

9 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.29 EconomicProfits Implicit costs (including a normal profit) ExplicitCosts Accounting costs (explicit costs only) AccountingProfits Economic (opportunity) Costs TotalRevenue Figure 6-1 Economic Profit vs. Accounting Profit

10 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.310 Short Run and Long Run Short Run –Fixed Plant Long Run –Variable Plant

11 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.211 Total Product (TP) –total quantity produced Marginal Product (MP) Average Product (AP) change in total product change in labour input = total product units of labour = Short-Run Production Relationships

12 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.312 Law of Diminishing Returns marginal product eventually diminishes Short-Run Production Relationships

13 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.313 Units of labour TPMPAP 00 110 225 345 460 570 675 7 870 change in total product change in labour input MP= Table 6-1 Total, Marginal, and Average Product

14 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.314 Units of labour TPMPAP 00 110 225 345 460 570 675 7 870 10 15 20 15 10 5 0 -5 Increasing marginal returns Diminishing marginal returns Negative marginal returns Total, Marginal, and Average Product

15 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.315 Units of labour TPMPAP 00 110 225 345 460 570 675 7 870 10 15 20 15 10 5 0 -5 10.00 12.50 15.0015.0014.00 12.50 10.71 8.75 total product total labour input AP= Total, Marginal, and Average Product

16 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.316 AP MP TP increasing marginal returns diminishing marginal returns negative marginal returns Figure 6-2

17 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.317 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

18 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.318 Marginal and Average Values AP MP MP>APMP>AP MP<APMP<AP Average value rising Average value falling

19 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.419 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

20 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.420 Per-Unit, or Average, Costs

21 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.421 Marginal Cost Marginal cost is the extra, or additional, cost of producing one more unit of output Illustrated…

22 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.422 100 QTFCTVCTCAFCAVCATCMC 0 1 2 3 4 5 6 7 8 9 10 0 90 170 240 300 370 450 540 650 780 930 100 190 270340400 470 550 640 750 880 1030 TC=TFC + TVC

23 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.423 TFC Total Cost is the Sum of Fixed Cost and Variable Cost Figure 6-3

24 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.424 TFC TVC TC Total Cost is the Sum of Fixed Cost and Variable Cost Add vertically to get TC

25 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.425 QTFCTVCTCAFCAVCATCMC 01000 1 90 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930 100 190 270340400 470 550 640 750 880 1030 100 50 33.332520 16.67 14.29 12.50 11.11 10 AFC=TFC / Q 90 85 807574 75 77.14 81.25 86.67 93 AVC=TVC / Q 190 135 113.3310094 91.67 91.43 93.75 97.78 103 ATC=TC / Q

26 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.426 QTFCTVCTCAFCAVCATCMC 01000 1 90 2100170 3100240 4100300 5100370 6100450 7100540 8100650 9100780 10100930 100 190 270340400 470 550 640 750 880 1030 100 50 33.332520 16.67 14.29 12.50 11.11 10 90 85 807574 75 77.14 81.25 86.67 93 190 135 113.3310094 91.67 91.43 93.75 97.78 103 90 80 70 60 70 80 90 110 130 150 MC=  TC /  Q Note: MC is graphed at average Q 2.5

27 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.427 AFC AFC continually declines as fixed cost is spread over more and more units AFC, AVC, and ATC Figure 6-5

28 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.428 AFC AVC AVC is U-shaped: it starts to rise when AP starts to fall AFC, AVC, and ATC

29 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.429 AFC ATC AVC Get ATC by vertically summing AFC and AVC AFC, AVC, and ATC

30 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.430 AFC ATC MC AVC MC cuts ATC and AVC at minimum points MC, AVC, and ATC

31 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.431 Labour Costs (dollars) Average Product and Marginal Product Output MP AP MCAVC Figure 6-6 Productivity Curves and Cost Curves

32 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.432 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

33 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.433 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

34 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.434 Technology improved technology lower costs cost curves shift down curve shifts depend on whether technology affects FC, VC, or both Shifts of Cost Curves

35 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.535 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...

36 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.536 ATC-1ATC-2 ATC-3 ATC-4 ATC-5 Choose the best plant for every output level Figure 6-7 The Long-Run Average-Total-Cost Curve These choices determine the LRATC curve

37 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.537 The number of possible plant sizes is virtually unlimited The number of possible plant sizes is virtually unlimited Figure 6-8 The Long-Run Average-Total-Cost Curve The LRATC curve just envelops the short-run cost curves LRATC

38 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.538 Economies of Scale –Labour Specialization –Managerial Specialization –Efficient Capital –Other Factors Diseconomies of Scale Constant Returns to Scale

39 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.539 Economies of scale LRATC Figure 6-9 Economies and Diseconomies of Scale Constant returns to scale Diseconomies of scale

40 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.540 Minimum Efficient Scale ATC-1ATC-2 ATC-3 ATC-4 ATC-5 MES is the smallest level of output that minimizes LRATC

41 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.541 Minimum Efficient Scale LRATC Relatively large MES Relatively large MES natural monopoly Relatively large MES Relatively large MES natural monopoly MESMES

42 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.542 Minimum Efficient Scale MESMES LRATC Relatively small MES Relatively small MES competitive industry Relatively small MES Relatively small MES competitive industry

43 ©2007 McGraw-Hill Ryerson Ltd.Chapter 6.543 Applications and Illustrations Successful Startup Firms The Daily Newspaper The Verson Stamping Machine Aircraft and Concrete Plants

44 ©2007 McGraw-Hill Ryerson Ltd.Chapter 644 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

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