Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
06.11.2016 Firm / Production Costs 7 Cost Concepts (Short-run) 1. 2. 3. 4. 5. 6. 7. Total Fixed Cost Total Variable Cost Total Cost Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost (TFC) (TVC) (TC=TVC+TFC) (AFC=TFC/Q) (AVC=TVC/Q) (AC=AFC+AVC) (MC= ∆AVC/∆Q 1 06.11.2016 Fixed and Variable Costs • Costs of production may be divided into fixed costs and variable costs. • Fixed costs are those costs that do not vary with the quantity of output produced. • Variable costs are those costs that do vary with the quantity of output produced. Formula of Total Cost • Total Costs (TC) – Total Fixed Costs (TFC) – Total Variable Costs (TVC) – Total Costs (TC) TC = TFC + TVC 2 06.11.2016 Total Fixed Cost (TFC) • Total fixed cost (TFC) is more commonly referred to as "sunk cost" or "overhead cost." • Total fixed cost is the cost associated with the fixed input. – Examples: include the payment or rent for land, buildings and machinery. – The fixed cost is independent of the level of output produced. – Graphically, depicted as a horizontal line Since TFC is constant, its graph is a horizontal line. Price TFC Quantity 3 06.11.2016 Total variable cost (TVC) • Total variable cost (TVC) refers to the cost that changes as the amount of output produced is changed. • Total variable cost is the cost associated with the variable input. – Examples: purchases of raw materials, payments to workers, electricity bills, fuel and power costs. – Total variable cost increases as the amount of output increases. • If no output is produced, then total variable cost is zero; • the larger the output, the greater the total variable cost. The TVC curve is upward sloping. Price TVC It is often drawn like a flipped over S, first getting flatter & flatter, & then steeper & steeper. This shape reflects the increasing & then decreasing marginal returns we discussed in the section on production. Quantity 4 06.11.2016 Total cost (TC) • Total cost (TC) is the sum of total fixed cost and total variable cost TC=TFC+TVC – As the level of output increases, total cost of the firm also increases. Price TC (Total Cost) TVC (Total Variable Cost) TFC (Total Fixed Cost) Q 0 “TOTAL” COST CURVES 5 06.11.2016 Total Cost Price TC TC = TFC + TVC The TC curve looks like the TVC curve, but it is shifted up, by the amount of TFC. TFC Quantity Average Costs • Different types of average cost (ATC, AVC, and AFC) are irrelevant to earning the greatest possible level of profit – Common error—sometimes made even by business managers—is to use average cost in place of marginal cost in making decisions • Problems with this approach – ATC includes many costs that are fixed in short-run—including cost of all fixed inputs such as factory and equipment and design staff – ATC changes as output increases • Correct approach is to use the marginal cost and to consider increases in output one unit at a time – Average cost doesn’t help at all; it only confuses the issue • Average cost should not be used in place of marginal cost as a basis for decisions 6 06.11.2016 Average Costs • Average Costs – Average costs can be determined by dividing the firm’s costs by the quantity of output it produces. – The average cost is the cost of each typical unit of product. • Average Costs – Average Fixed Costs (AFC) – Average Variable Costs (AVC) – Average Total Costs (ATC) ATC = AFC + AVC AVERAGE COSTS AFC Fixed cost FC Quantity Q AVC Variable cost VC Quantity Q ATC Total cost TC Quantity Q 7 Costs (dollars) 06.11.2016 • The AFC curve slopes downward & gets closer & closer to the horizontal axis. AFC Quantity Costs (dollars) Average Variable Cost AVC Quantity 8 Costs (dollars) 06.11.2016 ATC AVC AFC Quantity Average Total Cost Curve and Its Shape • The average total-cost curve is U-shaped. • At very low levels of output average total cost is high because fixed cost is spread over only a few units. • Average total cost declines as output increases. • Average total cost starts rising because average variable cost rises substantially. • The bottom of the U-shaped ATC curve occurs at the quantity that minimizes average total cost. This quantity is sometimes called the efficient scale of the firm. 9 06.11.2016 • Average fixed cost (AFC) decreases as output increases. • The average variable cost curve (AVC) is Ushaped. • The average total cost curve (ATC) is also Ushaped. Average Total Cost Price ATC AVC Like AVC, ATC is U-shaped, but it reaches its minimum after AVC reaches its minimum. This is because ATC = AVC +AFC & AFC continues to fall & pulls down ATC. Quantity 10 06.11.2016 Marginal Costs • Marginal Cost – Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production. – Marginal cost helps answer the following question: • How much does it cost to produce an additional unit of output? Formula of Marginal Cost • Marginal Cost = Change in Total Cost/Change in Quantity = Change in Variable Cost/Change in Quantity MC (change in total cost) TC (change in quantity) Q 11 06.11.2016 Marginal Cost Curve and Its Shape • Marginal cost rises with the amount of output produced. – This reflects the property of diminishing marginal product. While MC is U-shaped, it is often drawn so it extends up higher on the right side. $ MC Quantity 12 06.11.2016 The MC must intersect the ATC at its minimum & the AVC curve at its minimum. MC $ ATC AVC Quantity Total Costs of Production Quantity Total Fixed Cost Total Variable Cost Total Cost Average Cost MC AC 130 30 130 50 150 20 75 60 160 10 53.3 100 65 165 5 41.25 5 100 75 175 10 35 6 100 95 195 20 32.5 7 100 125 225 30 32.14 8 100 165 265 40 33.12 L TFC TVC 0 100 0 1 100 30 2 100 3 100 4 TC Marginal Cost 100 - - 9 100 215 315 50 35 10 100 275 375 60 37.5 13 06.11.2016 1400 TC 1200 1000 TVC 800 600 400 TFC 200 0 0 2 4 6 8 180 160 140 120 100 80 60 40 20 0 10 12 MC AC AVC 0 2 4 6 8 10 12 • Average fixed cost declines steadily over the range of production. • Average variable cost declines at first but starts to increase after 4 units. • Average total cost also declines at first but starts to increase after 4 units. • Marginal cost declines and then starts to increase once the third unit of output is produced. • When MC < AVC, AVC is falling. • When MC > AVC, AVC is rising. • When MC = AVC, AVC is at its minimum. 14 06.11.2016 Relationship between MC and ATC • Relationship between Marginal Cost and Average Total Cost – Whenever marginal cost is less than average total cost MC < ATC average total cost is falling. – Whenever marginal cost is greater than average total cost MC > ATC, average total cost is rising. – The marginal-cost curve crosses the average-total-cost curve at the efficient scale. • Efficient scale is the quantity that minimizes average total cost. P TVC Inflection point 0 q1 (Total Variable Cost) MC Q AVC q1 15 06.11.2016 The Marginal Cost curve passes through the minimum point of the AVC curve. P MC (Marginal Cost) It is also U-shaped. First it decreases, reaches a minimum and then increases. AVC (Average Variable Cost) Minimum AVC 0 q1 Q MC P AC AVC AFC 0 q1 Q The “PER UNIT” COST CURVES 16 06.11.2016 Example 1. • Produce 3 units at an average cost of £1 per unit. Total cost: £3 • Increase production by 1 unit. The cost of the additional unit is 0.6 £ – this is the MC • Total cost = £3.6, total output = 4 units. • Average cost = £0.9 per unit. • If MC was £1.4, total cost = £4.4 • Average cost = £1.1 per unit. Example 2. • Produce 1,500 tonnes of wheat at an average cost of £50 per tonne. • Total cost: £75,000 • Increase production by 1 tonne, but the cost of the additional tonne is 80 £ – this is the marginal cost • Total cost = £75,080, total output =1,501 t • Average cost = £50.02 17 06.11.2016 The Short Run Cost Function • A change in input prices will shift the cost curves. – If fixed input costs are reduced then ATC will shift downward. AVC and MC will remain unaffected. The Short Run Cost Function • A change in input prices will shift the cost curves. – If variable input costs are reduced then MC, AVC, and AC will all shift downward. 18 06.11.2016 Costs in the Short Run and in the Long Run • For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered. – In the short run, some costs are fixed. – In the long run, fixed costs become variable costs. Short-Run Cost Curves and Long-Run Cost Curves • Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its shortrun cost curves. 19 06.11.2016 Economic Time & Production Costs • Law of Diminishing Returns – As additional units of a variable factor are added to a fixed factor, beyond some point the additional product from each additional unit of the variable factor decreases. • Long-Run Costs – Long-Run Total Cost, Average Cost, & Marginal Cost • Total cost, per unit cost, and cost per additional unit of output, respectively. 20 06.11.2016 Economic Time & Production Costs Long-run total cost is the total expenditure for each level of output in the long run. Long-run average total cost equals unit cost; and longrun marginal cost measures the cost of producing an additional unit of output. The Long Run Cost Function • In the long run, all inputs to a firm’s production function may be changed. • There are no fixed inputs and thus there are no fixed costs. • Decisions regarding long-run cost of operations are considered to be part of the management’s planning horizon. 21 06.11.2016 Scale of Production (Capacity Level) A B C D E F Total Product (Output/month) 10,000 20,000 30,000 40,000 50,000 60,000 Long-Run Total Cost (LRTC) 50,000 90,000 120,000 150,000 200,000 260,000 Long-Run Marginal Cost (LRMC) 5.00 4.00 3.00 3.00 5.00 6.00 Long-Run Average Cost (LRAC) 5.00 4.50 4.00 3.75 4.00 4.33 LRTC = LTC LRMC = LMC LRAC = LAC 7 LRMC 6 5 LRAC 4 3 2 1 0 0 10000 20000 30000 40000 50000 60000 70000 The long-run cost function exhibits the same pattern of behavior as the short-run cost function. 22 06.11.2016 LTC LTC Long Run Total Cost All inputs are variable in the long run. There are no fixed costs. Total Product Q LONG-RUN TOTAL COST CURVE The LAC • The LAC curve is curve that envelopes all possible plant sizes. Also known as „planning curve”. • It traces the lowest average cost of producing each level of output. • It is U-shaped because of – Economies of Scale – Diseconomies of Scale 23 06.11.2016 Cost SRATC1 At a relatively low output level, in the short run, the firm might have SRATC1 curve as its short run average cost curve. Quantity of output Cost SRATC2 At a slightly higher output level, in the short run, the firm might have SRATC2 curve as its short run average cost curve. Quantity of output 24 06.11.2016 Cost SRATC3 At a still higher output level, in the short run, the firm might have SRATC3 curve as its short run average cost curve. Quantity of output Cost LRATC SRATC1 SRATC2 SRATC5 SRATC3 SRATC4 In the long run, the firm can pick any appropriate plant size. At each output level, the firm picks the plant that has the SRATC curve with the lowest value. Quantity of output 25 06.11.2016 Cost LRATC SRATC1 SRATC2 SRATC5 SRATC3 SRATC4 So, the LRATC curve is made up of segments of the SRATC curves. Quantity of output In many industries, the number of possible plant sizes is virtually unlimited. Then the LRATC curve is made up of points of tangential of the theoretically unlimited number of SRATC curves. Then the long run ATC curve is smooth. 26 06.11.2016 Cost LRATC SRATC1 SRATC5 SRATC2 SRATC4 SRATC3 Quantity of output Economic Time & Production Costs • Phases of Long-Run Average Total Cost – Economies of Scale • Occurs when the increasing size of production in the long run causes the per unit cost of production to fall. – Diseconomies of Scale • Occur when the increasing size of production in the long run causes the per unit cost of production to rise. – Constant Returns to Scale • Occur in the range of production levels in which longrun average total cost is constant. 27 06.11.2016 The downward-sloping section of the Long Run ATC curve reflects Economies of Scale. Economies of Scale: As plant size increases, there are factors which lead to lower average costs of production. • • • Labor Specialization: Jobs can be subdivided and workers performing very specialized tasks can become very efficient at their jobs. Managerial Specialization: Management can also specialize in a larger firm (in areas such as marketing, personnel, or finance). Equipment that is technologically efficient but only effectively utilized with a large volume of production can be used. 28 06.11.2016 Possible Reasons for Economies of Scale • Specialization in the use of labor and capital • Indivisible nature of many types of capital equipment • Productive capacity of capital equipment rising faster than purchase price • Economies in maintaining inventory of replacement parts and maintenance personnel • Discounts from bulk purchases • Lower cost of raising capital funds • Spreading of promotional and research and development costs • Management efficiencies (line and staff) The upward-sloping section of the Long Run ATC curve reflects Diseconomies of Scale. 29 06.11.2016 Diseconomies of Scale: As plant size increases, there are factors which lead to higher average costs of production. • • Expansion of the management hierarchy leads to problems of communication, coordination, and bureaucracy (red tape), and the possibility that decisions will be wrong. („The left hand doesn’t seem to know what the right hand is doing.”) The result is reduced efficiency. In large facilities, workers may feel alienated and discoraged to work as much as they should. Then additional supervision may be required and that adds to the costs. Sometimes there is a segment of the LR ATC curve which is horizontal. In that section, the LR ATC is constant, & there are Constant Returns to Scale. 30 06.11.2016 Average Total Cost in the Short and Long Run Average Total Cost ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory ATC in long run $12,000 10,000 Economies of scale 0 Constant returns to scale 1,000 1,200 Diseconomies of scale Quantity of Cars per Day $/TL LRAC Q economies of scale constant returns to scale (neither economies nor diseconomies) diseconomies of scale 31 06.11.2016 • Economic Time & Production Costs Phases of Long-Run Average Total Cost – Economies of Scale • Occurs when the increasing size of production in the long run causes the decrease in unit cost of production. • Economies of scale refers to the firm’s property whereby longrun average total cost falls as the quantity of output increases. – Diseconomies of Scale • Occur when the increasing size of production in the long run causes the per increase in unit cost of production. • Diseconomies of scale refers to the firm’s whereby long-run average total cost rises as the quantity of output increases. – Constant Returns to Scale • Occur in the range of production levels in which long-run average total cost is constant. • Constant returns to scale refers to the property whereby longrun average total cost stays the same as the quantity of output increases LMC COST SMC2 SMC1 0 LAC SAC2 SAC1 Q1 Q 32 06.11.2016 Long Run Average Cost and Long Run Marginal Cost • Long-run Average Cost (LAC) curve – is U-shaped. – the envelope of all the short-run average cost curves; – driven by economies and diseconomies of size. • Long-run Marginal Cost (LMC) curve – Also U-shaped; – intersects LAC at LAC’s minimum point. The Learning Curve • A line showing the relationship between labor cost and additional units of output. • Downward slope of the learning curve indicates that the additional cost per unit declines as the level of output increases because workers improve with practice. • The reduction in cost from this particular source of improvement is referred to as the learning curve effect. 33 06.11.2016 • The learning curve effect is measured by the percentage decrease in additional labor cost each time the output doubles. • Learning rate is given by the following formula: AC 2 x 100 learning rate 1 AC 1 • This is the rate at which average cost falls as cumulative output doubles. unit labor cost cumulative output over time 34 06.11.2016 unit labor cost C B A LRACt LRACt+1 Qt Qt+1 cumulative output over time From C to B, learning effect From B to A, economies of scale effect The Learning Curve • Measures the percentage decrease in additional labor cost each time output doubles. – An “80 percent” learning curve implies that the labor costs associated with the incremental output will decrease to 80% of their previous level. 35 06.11.2016 The Learning Curve • A downward slope in the learning curve indicates the presence of the learning curve effect – Why? Workers improve their productivity with practice • The learning curve effect shifts the SRAC downward Economies of Scope • The reduction in a firm’s unit cost that results from producing two or more goods jointly rather than separately. • Sharing certain aspects of the production process, the firm is able to decrease its unit cost. 36 06.11.2016 We’ve discussed economies & diseconomies of scale. When a firm produces more than one product, it may also experience economies or diseconomies of scope. Economies of scope exist when a single firm producing multiple products jointly can produce them more cheaply than if each product was produced by a separate firm. Economies of scope may occur because 1. Production of different products use common inputs. • Example: Automobile & truck production may use the same factory assembly line and raw materials. 2. Production of one good results in production of by-products that company also can sell. • Example: A cattle producer raises cattle to sell for beef, but can also sell leather. 37 06.11.2016 A measure of economies of scope is TC(Q1 ) TC(Q 2 ) – TC(Q1 Q 2 ) TC(Q1 Q 2 ) where TC(Q1) is the total cost of producing Q1 units of product 1 only, TC(Q2) is the total cost of producing Q2 units of product 2 only, & TC(Q1+Q2) is the total cost of producing them jointly. This measure indicates the savings of joint production compared to separate production, as a percentage of joint production. Example 1: The total cost of producing Q1 units of product 1 only is 50,000. The total cost of producing Q2 units of product 2 only is 90,000. The total cost of producing them jointly is 120,000. Determine if there economies or diseconomies of scope, and measure them. There are economies of scope, since joint production is less costly than the sum of the separate productions. TC(Q1 ) TC(Q 2 ) – TC(Q1 Q 2 ) TC(Q1 Q 2 ) 20,000 50,000 90,000 120,000 120,000 120,000 0.167 38 06.11.2016 Example 2: The total cost of producing Q1 units of product 1 only is 50,000. The total cost of producing Q2 units of product 2 only is 90,000. The total cost of producing them jointly is 150,000. Determine if there economies or diseconomies of scope, and measure them. There are diseconomies of scope, since joint production is more costly than the sum of the separate productions. TC(Q1 ) TC(Q 2 ) – TC(Q1 Q 2 ) TC(Q1 Q 2 ) 10,000 50,000 90,000 150,000 150,000 150,000 0.067 Example 3: The total cost of producing Q1 units of product 1 only is 50,000. The total cost of producing Q2 units of product 2 only is 90,000. The total cost of producing them jointly is 140,000. Determine if there economies or diseconomies of scope, and measure them. There are neither economies nor diseconomies of scope, since joint production costs the same amount as the sum of the separate productions. TC(Q1 ) TC(Q 2 ) – TC(Q1 Q 2 ) TC(Q1 Q 2 ) 0 50,000 90,000 140,000 140,000 140,000 0 39 06.11.2016 To review and extend knowledge • MIT Open Courseware - freely available video recordings of introductory level microeconomics classes at MIT corresponding to lecture 2 of our course 1. Introduction to producer theory (00:37:21) • http://www.youtube.com/watch?v=A6FOBdtbcz4&list= SP61533C166E8B0028&index=9 2. Productivity and costs (00:47:30) • http://www.youtube.com/watch?v=Q4iKuKAjzK0&list= SP61533C166E8B0028&index=10 40