Download Chapter 9

Chapter 9
The costs of production
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-1
Learning objectives
• Define economic and other categories of costs
• Examine how various cost concepts vary
in the short and long run
• Develop cost-analysis tools that will be useful
in later chapters
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-2
Economics costs
• Economic costs are opportunity costs
– It is the amount of other products that must be foregone
or sacrificed to obtain a unit of any product
• Explicit costs
– Monetary payments to non-owners of the firm for
resource supplies
• Implicit costs
– Money payments that the self-employed resource could
have earned in their next best alternative employment
• Normal profit is a cost
– minimum payment for entrepreneurship required to retain
the entrepreneur in a given line of production
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-3
Economic, or pure, profits
• Economic profit
– The difference between total revenue and opportunity
cost of all inputs
– Accounting profit equals total revenue less explicit costs
• Accounting profit includes economic profit and all
implicit costs
Economic
profit
=
Total
revenue
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
–
Opportunity cost
of all inputs
9-4
Summary of costs and profits
Profits to an
accountant
Economic (opportunity) costs
Profits to an
economist
Economic
profits
Implicit costs
(including a
normal profit)
Explicit
Costs
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Accounting
profits
Total
Revenue
Accounting
costs (explicit
costs only)
9-5
Short and long run
• Variable resources
– Factors of production whose quantity can be increased
or decreased during a particular period
• Fixed resources
– Factors of production whose quantity cannot be
increased or decreased during a particular period
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-6
Short and long run (cont.)
• Short run
– A period of time where at least one factor is variable
and all others fixed
• Long run
– A time period where all factors can be varied
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-7
Short-run production costs
• Law of diminishing returns
– As successive units of a variable resource (say, labour)
are added to a fixed resource (say, capital) beyond some
point the extra, or marginal product attributable to each
additional unit of the variable resource will decline
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-8
Inputs of
the
variable
resource
Total
product
0
1
2
3
4
5
6
7
8
9
0
10
25
37
47
55
60
63
63
62
]
]
]
]
]
]
]
]
]
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Extra or
marginal
product
10
15
12
10
8
5
3
0
–1
Average
product
10.0
12.5
12.3
11.8
11.0
10.0
9.0
7.9
6.9
9-9
Short-run production costs
(cont.)
• Marginal product (MP)
– Additional output resulting from the addition of an extra
unit of a resource
• Average product (AP)
– The total output per unit of resource employed
– Total product divided by number of workers
• Total product (TP)
– The total output of a good produced by a firm
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-10
Average product, AP, and
marginal product, MP
Total product, TP
Law of diminishing returns
Total output
Quantity of labour
Average
product
Quantity of labour
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Marginal
product
9-11
Least-cost rule
• The cost of any output is minimised when
the marginal product per dollar’s worth of
each resource is used
• Given two resources, labour and raw materials,
cost is minimised when:
MP of labour
Price of labour
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
=
MP of materials
Price of materials
9-12
Fixed, variable & total costs
• Fixed costs
– Do not vary with changes in output
• Variable costs
– Vary with changes in output
• Total costs
– The sum of fixed and variable costs at each level
of output
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-13
Total costs
TC
TVC
Costs (dollars)
Fixed cost
Total
cost
Variable cost
TFC
Quantity
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-14
Average costs
• Average fixed cost
TFC
AFC =
Q
• Average variable cost
AVC =
TVC
Q
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-15
Average costs (cont.)
• Average total cost
Total cost
ATC =
= AFC + AVC
Quantity
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-16
Short-run average costs (dollars)
The average cost curves
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
ATC
AVC
AFC
quantity
9-17
Marginal costs
• Marginal cost (MC)
– The extra, or additional cost of producing one more
unit of output
Marginal cost =
Change in total costs
Change in quantity
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-18
Short-run average costs (dollars)
Marginal costs (cont.)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
MC
ATC
AVC
AFC
Quantity
9-19
Marginal costs & marginal
products
• Given the price of the variable resource, increasing
returns (marginal product) will be reflected in a
declining marginal cost, and diminishing returns
(marginal product) in a rising marginal cost
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-20
Marginal cost relationships
• When MC > ATC
– ATC increases
• When MC < AC
– ATC falls
• When ATC = MC
– ATC is at its minimum
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-21
Shifts in the cost curves
• Total and per unit cost curves developed
so far are based on the assumption that
technology is fixed
• If technology changes, and more efficient
technology comes into operation, the
productivity of all inputs would improve. The
marginal and average cost curves would
move downwards
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-22
Production costs in the long run
• All factors are variable in the long run
– All costs are variable
• Long-run cost curve
– Shape depends on economies of scale
– Scale is defined as different levels of plant utilisation
• The long-run ATC shows the lowest per-unit
cost at which any output can be produced after
the firm has had time to make all appropriate
adjustments in its plant size
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-23
Long-run AC curve: five possible plant size
For every plant capacity size
there is a short-run ATC curve,
and every ATC has a minimum cost
ATC-5
Unit costs
ATC-1
ATC-4
ATC-2
20
30
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
40
ATC-3
50
60
Output
9-24
Long-run AC curve: unlimited number
of plant size
Unit costs
The long-run ATC just
‘envelops’ all the short-run ATC
curves
Long-run
ATC
Output
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-25
Economies & diseconomies
of scale
• Economies of scale
– ATC falls as plant size increases
• Diseconomies of scale
– ATC increases as plant size increases
• Constant returns to scale
– ATC constant as plant size increases
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-26
Economies & diseconomies
of scale (cont.)
Economies of scale arise from:
• Labour specialisation
• Managerial specialisation
• Efficient capital
• By-products
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-27
Shape of long-run costs
• May take on many shapes
• U-shaped curve would initially involve falling
ATC then increasing ATC as diseconomies
of scale set in
• Other shapes are possible
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-28
Long-run ATC curves
Constant returns
to scale
Unit costs
Economies
of scale
Diseconomies
of scale
Long-run ATC
q1
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
Output
q2
9-29
Long-run ATC curves (cont.)
Unit costs
Where extensive
economies of
scale exist
Long-run ATC
Output
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-30
Long-run ATC curves (cont.)
Unit costs
Where economies
of scale are
quickly exhausted
Long-run ATC
Output
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-31
Minimum efficiency scale (MES)
& industry structure
• MES is the smallest level of output at which
a firm can minimise long-run average costs
• Natural monopoly
– A market situation in which unit costs are minimised
by having a single firm produce the particular good
or service
– MES cannot be achieved in the market due to the size
and cost of capital stock required for operation
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-32
Next chapter:
Perfect competition
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 8e, by Jackson & McIver
By Muni Perumal, University of Canberra, Australia
9-33