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Chapter 8 Production and Costs

Chapter 8 Production and Costs. Marginal Physical Product (MPP). What is the variable input? What is the variable cost?. So…. As more labor (VARIABLE INPUT) are added to land (FIXED INPUT) the variable inputs would yield smaller and smaller additions to output. Marginal Physical Product.

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Chapter 8 Production and Costs

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  1. Chapter 8Production and Costs

  2. Marginal Physical Product (MPP) • What is the variable input? • What is the variable cost?

  3. So… • As more labor (VARIABLE INPUT) are added to land (FIXED INPUT) the variable inputs would yield smaller and smaller additions to output

  4. Marginal Physical Product

  5. Crowding Problem • The point at which MPP declines • Shows the law of diminishing returns

  6. Average Physical Productivity • Output divided by Inputs (usually labor) • Good for comparing firms or countries.

  7. So find that… • MC and MPP are related • What is the relationship?

  8. In –class exercise 10 Does MPP show Diminishing Returns???

  9. Law of Diminishing Marginal Returns

  10. Marginal Cost

  11. Does this relationship make sense? • Yes.. • If productivity increases what would happen to costs?? • Decrease (MPP increase & MC decrease) • Productivity decreases?? • Increase (MPP decreases & MC increases)

  12. MPP determines shape of MC • MPP must have a declining part because of diminishing returns • Can also define MC as:

  13. In-class exercise 11 How do we calculate these costs?? Give two ways to get to the cost…

  14. Average-Marginal Rule • Can use to see what the ATC and AVC curve look like • Tells us what happens when MC is above or below the “average” curves • If MC is above AVC and ATC • AVC and ATC are rising • If MC is below AVC and ATC • AVC and ATC are falling

  15. From Average-Marginal Rule can infer… • MC intersects the AVC and ATC curves at their MINIMUM POINTS • Cannot infer anything about AFC

  16. Average and Marginal Cost Curves

  17. Average and Marginal Cost Curves

  18. So… • MC gains it shape from??? • MPP and law of diminishing marginal returns • MC below ATC: What is ATC curve doing? • Falling • MC above ATC: What is ATC curve doing? • Rising

  19. Average and Marginal Cost Curves

  20. Tying Products to Costs A CLOSER LOOK MPP Variable Input When MC is below ATC, AVC MC Production in the short run: at least one fixed input When MC is above ATC, AVC MPP Variable Input MC

  21. Now switching to the Long Run • When does Long Run start? • As soon as all inputs (costs) are VARIABLE • No fixed costs • Important curves • LRTC • LRATC • LRMC

  22. Short Run vs. Long Run • Short Run assumes FIXED plant size • Each plant size has a unique ATC curve associated with it • SRATC • LRATC combines all the SRATC curves • Which points of the SRATC??? • Minimum points

  23. Why minimum? • LRATC shows the lowest average cost at which a firm can produce any given level of output • LRATC is the lower ENVELOPE of the SRATC curves • Called envelope curve

  24. Long-Run Average Total Cost Curve (LRATC)

  25. Isn’t the LRATC curve smooth?? • Yes!! • Have infinitely many SRATC curves so it would be smooth if use all curves • Each SRATC curve touches the LRATC curve only once

  26. Shape of LRATC • U-shaped • Decreasing, Flat, then Increasing • Important when finding optimal long run output level

  27. Long-Run Average Total Cost Curve (LRATC)

  28. Economies of Scale • Downward part of LRATC • Average costs decrease as output increases • If have a 1% increase in input usage what happens to output?? • Increases by MORE than 1% • Specialization

  29. Constant Returns to Scale • Flat portion of LRATC • Costs remain the same as increase output • If have a 1% increase in input usage what happens to output?? • Output increases by EXACTLY 1% • First point of constant returns to scale is called MINIMUM EFFICIENT SCALE

  30. Diseconomies of Scale • Upward sloped portion of LRATC • Costs are rising as we increase output • If have a 1% increase in input usage what happens to output? • Increases by LESS THAN 1% • Why??? • Firm too large (bad communication or coordination problems)

  31. Long-Run Average Total Cost Curve (LRATC)

  32. Are economies, diseconomies, and constant returns to scale in SR, LR, or both??? • LONG RUN ONLY!!! • Why? • Inputs necessary for production are able to be changed • No fixed inputs

  33. Is this the same as diminishing returns? • NO • Diminishing returns is from using ONE plant size intensely • Short run • Economies of scale is from CHANGING plant size • Long run

  34. Review • Economies of Scale • LRATC falling • Constant Returns to Scale • LRATC flat • Diseconomies of Scale • LRATC rising

  35. Why does economies of scale exist? • Large firms offer more opportunity for workers to specialize • Growing firms can take advantage of efficient mass production techniques • Smooth cost over more units produced

  36. Why does diseconomies of scale exist? • Communication problems • Shirking • Management problems

  37. Why is minimum efficient scale important? • Lowest output level at which ATC are minimized • Which has a cost advantage?? • Small firm at minimum efficient scale point • Larger firm producing more output but still within constant returns to scale area • Neither

  38. Long-Run Average Total Cost Curve (LRATC)

  39. Minimum Efficient Scale for Six Industries

  40. Where would you expect to find less firms? (using MES) • Firms with higher MES • Why?? • Produce until MES • If MES is higher then each firm will be producing more…so need less firms to cover quantity wanted by economy • Many SHOE companies (MES = .2) • Few REFRIGERATOR companies (MES = 14)

  41. Efficient Number of Firms • 100 divided by MES • 100% of goods are wanted by consumers • MES is the percentage of consumption each firm will provide • Cigarette firm’s MES = 6.6 • Need 15 firms • Petroleum firm’s MES = 1.9 • Need 52 firms • Thus a larger MES means less firms needed

  42. What cause SRTC, LRTC, and MC to shift? • Taxes • Does it affect FC?? • Only if it is a lump sum tax (tax for existing) • If it is a per unit tax then FC doesn’t change • How does it change curves?? • Input prices • How does it change curves?? • Technology • Either improves production process (use less inputs) or lower input prices • How does it change curves??

  43. Homework • Chapter 8 • Questions: 3, 5, 10, and 11 • Working with numbers and graphs • Questions 3, 6, and 7

  44. In-class exercise 12 Do we understand Chapter 8??

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