Download Unit 3 Lesson 1

Unit 3 Lesson 1
Introduction, costs, productivity
(1)
The Costs of Production
ECONOMIC COSTS: costs in economics deal with forgoing The opportunity to produce alternative
goods and services. This is the same thing as opportunity costs.
EXPLICIT COSTS: payment to non-owners
ex: If I invest money in my business that money could have been used elsewhere. If I work in that
business, I could have worked (earned money) elsewhere.
IMPLICIT COSTS: what the resources could have earned in their best alternative employment. Give
example of programmer that starts own business that could have made 100,000 in another job as
opposed to being in business for himself.
NORMAL PROFIT: minimum amount of money needed to keep the business operating. The implicit
costs are included here. Implicit costs are included here. (Also called zero economic profit)
Total Revenue:
Explicit Costs :
Implicit Costs :
Economic Profit
200,000
100,000
100,000
0
ECONOMIC PROFIT: TOTAL REVENUE (TR) - (All costs implicit and explicit) This is also called
pure profit.
Notice it includes normal profit.
Total Revenue:
200,000
Explicit Costs :
90,000
Implicit Costs :
100,000
Economic Profit
10,000 (This means you are making $10,000 more than you would have made
in your next best alternative.
Economic profit is not the same thing as accounting profit. Accounting profit is TR - Explicit
costs. It does not build in any profits.
Short Run: A time period that is too short to vary the size of production. They can not expand their
plant...
Long Run period of time extensive enough for the firm to change quantities of all resources employed
in production (Plant, Labor...)
Law of Diminishing Marginal Returns: as successive units of a variable resource are added to a fixed
resource, beyond some point the extra, or marginal, product attributable to each additional unit of
variable resource will decline.
If you are a factory owner and your factory has 4 machines those four machines (and the land and
building) are your Fixed costs. With no workers you are producing nothing. If you add a worker the
marginal return is increased. If you add a second and third and fourth your marginal return increases.
It may even increase with the fifth. What happens if you add a seventh, or an eighth. Your marginal
return starts to diminish.
TOTAL PRODUCT: combined output from each level of labor and fixed capital goods.
Q labor
0
1
2
3
4
5
6
TP
0
15
34
48
60
62
60
MP
15
19
14
12
2
-2
AP
0
15
17
16
15
12.4
10
Notice that graphically the total product
1) Rises at an increasing rate. (Additional workers
help a lot.)
2) Increases at a decreasing rate. The slope has
changed. (Additional workers help but not as much as
they did.)
3) Reaches the maximum and then declines.
(Additional workers actually hinder production.)
MARGINAL PRODUCT: change in total output with
each additional input of labor.
Notice that graphically the Marginal Product curve is
the slope of the Total product curve. It measures the
degree of change associated with each additional
worker. This means it will go through the same three
stages.
1) It will rise when the Total Product is increasing
at an increasing rate.
2) It will begin to decrease when the Total Product
starts increasing at a decreasing rate.
3) It will be below zero when Total product starts
declining. When Total product is at its maximum the
Marginal Product is at zero.
AVERAGE PRODUCT: OUTPUT PER
WORKER. TP/# OF WORKERS
When the marginal product is rising the average
product must also be rising. The change in total
product is positive therefore the average product must
also be increasing. When marginal product is below
average product the average product must be
declining.
Unit 3 Lesson 2
(2)
Costs, revenue
FIXED COSTS: Those costs which in total do not vary
with changes in output.
These costs are the same no matter how many of
the products that are produced. This is because the
firm has had to buy things for production. They are
paying for them. (Ex. plant, equipment...) These can
only be changed in the long run.
VARIABLE COSTS: Those costs which change with
the level of output.
(Ex. Labor)
Notice that the variable costs do not increase at a
constant rate in relation to the increase in production.
This also goes back to the Law of Diminishing
Marginal Returns. The early units add more to Total
product than the later units but still cost the same.
Once total product starts to decrease it takes more and
more variable resources (which cost more) to obtain
the same increase in product.
TOTAL COSTS: Sum of fixed and variable costs at
each level of output.
Make them graph it before showing this.
AVERAGE FIXED COSTS: TFC/Q (NOTICE IT
DECLINES AS Q INCREASES)
Notice it declines as Q increases.
AVERAGE VARIABLE COSTS: TVC/Q
It declines, reaches a minimum and then increases.
The average variable cost is at first high because
the firm is understaffed and each worker is costly
because the firm is understaffed (workers will work
slower because they have to go from machine to
machine, they may not be able to work the machines as
well...
As you add more workers they specialization kicks
in and production gets more efficient. This leads to
lower costs.
Eventually the production gets so crowded that
workers are waiting in line to produce. This means
that each worker costs more per unit produced.
AVERAGE TOTAL COSTS: TC/Q OR
AFC + AVC
OVERHEAD 22-4
MARGINAL COSTS: Additional cost (change in cost)
of productin one more unit.
MC = _ TC/ _ Q OR _ VC/ _ Q
NOTICE that _VC/_Q works because fixed costs
do not change in the short run!
It is the Marginal Cost that determines if a firm
wants to produce an additional unit. The total cost
will increase.
If the marginal cost is below the average cost what will
happen to the average cost? It will fall. It
is like a test score. If the change in your score is less
than your average what happens.
OVERHEAD 22-5
Average
Fixed Cost
Average
Variable
Cost
1
100
90.00
190
100
90
2
50
85.00
135
100
80
3
33.33
80.00
113.33
100
70
Total
Product
Variable
Cost
Average
Total Cost
Fixed
Cost
Marginal
Cost
0
240
4
75.00
100
100
60
5
74.00
94
100
70
91.67
100
80
6
16.67
75.00
7
14.29
77.14
539
91.43
100
90
8
12.50
81.25
650
93.75
100
110
9
11.11
86.67
780
97.78
100
130
10
10.00
93.00
930
103
100
150
To calculate VC you take AVC and multiply it by Q.
MC
From this VC you can then get change in VC =
To calculate FC you take AFC and multiply by Q.
If labor is the only variable resource and each unit of labor was paid $10, what is the marginal
cost at each level of production?
Quantity of Labor
0
1
2
3
4
5
6
Total Product
0
15
34
48
60
62
60
Marginal Product
15
19
14
12
2
-2
Average Product
0
15
17
16
15
12.4
10
Marginal Cost
Now lets look at MP and MC together. If each
additional unit of labor added is done so at the same
price the MC will fall as long as the MP is rising. This
is because marginal cost is simply the (constant) price
or cost of an extra worker divided by his or her
marginal product.
This means that as long as MP is rising the MC will
be falling.
However, we know that the Law of Diminishing
Returns will eventually take over and the MP will
begin to fall.
When this happens the MC curve will rise.
This means that MP and MC are mirror images of
each other. See p. 427 and overhead 22-6.
The MC curve will intersect the ATC and AVC at their minimum point. This is because when the change
in cost is less than ATC the ATC will fall. If it is more than ATC than ATC will rise.
AVERAGE REVENUE: TR / Q. If all units are sold at the same price it is equal to that price.
AR = P*Q/Q = P
Total Revenue: PRICE X Q.
MARGINAL REVENUE: The extra revenue that results in selling one more unit.
Marginal Revenue = _ TR/_Q = P*Q2 - P*Q1 = P(Q2 - Q1) = Price
O2 - Q1
(Q2 - Q1)