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The Costs of Production

9. C H A P T E R. The Costs of Production. ECONOMIC COSTS. Economic Costs or Opportunity Costs Forgoing the opportunity to produce alternative goods and services. Explicit Costs Implicit Costs. Economic Profit. Total Revenue. Economic Cost. ECONOMIC COSTS. Normal Profits.

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The Costs of Production

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  1. 9 C H A P T E R The Costs of Production

  2. ECONOMIC COSTS Economic Costs or Opportunity Costs Forgoing the opportunity to produce alternative goods and services Explicit Costs Implicit Costs

  3. Economic Profit Total Revenue Economic Cost ECONOMIC COSTS Normal Profits • Treated as a cost • Required to attract & retain resources Economic or Pure Profits

  4. Economic Profit Accounting Profit Implicit costs (including a normal profit) Accounting costs (explicit costs only) Explicit Costs ECONOMIC COSTS Profits to an Economist Profits to an Accountant T O T A L R E V E N U E Economic (opportunity) Costs

  5. SHORT RUN AND LONG RUN Accounting: Short and long runis based upon annual chronology. Economics: Short runhas fixed plant capacity size. Long runhas variable plant capacity size.

  6. Change in Total Product Marginal Product = Change in Labor Input Total Product Average Product = Units of Labor SHORT-RUN PRODUCTION RELATIONSHIPS Total Product (TP) Marginal Product (MP) Average Product (AP)

  7. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Increasing Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Marginal Product Quantity of Labor

  8. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Diminishing Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Marginal Product Quantity of Labor

  9. SHORT-RUN PRODUCTION RELATIONSHIPS Law of Diminishing Returns Total Product Total Product, TP Negative Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Marginal Product Quantity of Labor

  10. Total Fixed Costs Average Fixed Costs = Quantity Total Variable Costs Average Variable Costs = Quantity SHORT-RUN PRODUCTION COSTS Fixed Costs Total Fixed Costs Variable Costs Total Variable Costs

  11. Total Costs Average Total Cost = Quantity Change in Total Costs Marginal Cost = Change in Quantity SHORT-RUN PRODUCTION COSTS Total Cost Total Fixed and Variable Costs Marginal Cost Total Variable Costs

  12. SHORT-RUN PRODUCTION COSTS Summary of Definitions Total Fixed Costs=TFC Total Variable Costs=TVC Total Costs=TC Average Fixed Costs=AFC Average Variable Costs=AVC Average Total Costs=ATC Marginal Cost= MC

  13. SHORT-RUN COSTS GRAPHICALLY TC Combining TVC With TFC to get Total Cost TVC Fixed Cost Costs (dollars) Variable Cost Total Cost TFC Quantity

  14. SHORT-RUN COSTS GRAPHICALLY MC Plotting Average and Marginal Costs ATC AVC Costs (dollars) AFC Quantity

  15. Average Product and Marginal Product Quantity of labor Costs (dollars) Quantity of output PRODUCTIVITY AND COST CURVES AP MP MC AVC

  16. LONG-RUN PRODUCTION COSTS For every plant capacity size... there is a short-run ATC curve. All such plant capacities can be plotted.

  17. LONG-RUN PRODUCTION COSTS Unit Costs Output

  18. LONG-RUN PRODUCTION COSTS Unit Costs Output

  19. LONG-RUN PRODUCTION COSTS The long-run ATC just “envelopes” all of the short-run ATC curves. Unit Costs Output

  20. LONG-RUN PRODUCTION COSTS Unit Costs long-run ATC Output

  21. ECONOMIES AND DISECONOMIES OF SCALE • Labor Specialization • Managerial Specialization • Efficient Capital • Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...

  22. ECONOMIES AND DISECONOMIES OF SCALE Economies of scale Unit Costs long-run ATC Output

  23. ECONOMIES AND DISECONOMIES OF SCALE Constant returns to scale Economies of scale Unit Costs long-run ATC Output

  24. ECONOMIES AND DISECONOMIES OF SCALE Constant returns to scale Diseconomies of scale Economies of scale Unit Costs long-run ATC Output

  25. ECONOMIES AND DISECONOMIES OF SCALE Where extensive economies of scale exist Unit Costs long-run ATC Output

  26. ECONOMIES AND DISECONOMIES OF SCALE Where economies of scale are quickly exhausted Unit Costs long-run ATC Output

  27. MINIMUM EFFICIENT SCALEAND INDUSTRY STRUCTURE Minimum Efficient Scale - MES Natural Monopoly • Applications & Illustrations • Rising Cost of Insurance and Security • Successful Start-Up Firms • The Verson Stamping Machine • The Daily Newspaper • Aircraft and Concrete Plants

  28. economic (opportunity) cost explicit costs implicit costs normal profit economic profit short run long run total product (TP) marginal product (MP) average product (AP) law of diminishing returns fixed costs variable costs total cost average fixed cost (AFC) average variable cost (AVC) average total cost (ATC) marginal cost (MC) economies of scale diseconomies of scale constant returns to scale minimum efficient scale natural monopoly KEY TERMS Copyright McGraw-Hill/Irwin, 2005 BACK END

  29. NEXT: Pure Competition Chapter 10

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