The Costs of Production

The Costs of Production

ECONOMIC COSTS • Explicit + Implicit costs • Explicit costs • Monetary payments to others • Implicit costs • Opportunity costs of owner • Self-owned resources • Self-employed resources

PROFITS • Accounting profit • Total revenue minus explicit cost • Economic profit • Total revenue minus implicit and explicit costs • Normal Profit = Implicit costs

Economic Profit Accounting Profit Implicit Costs (normal profit) Explicit Costs 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

SHORT RUN AND LONG RUN • The short run • Fixed plant capacity • Variable plant usage • Variable output • The long run • Variable plant capacity • Firms enter and exit

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)

Total Fixed Costs Average Fixed Costs = Quantity Total Variable Costs Average Variable Costs = Quantity SHORT-RUN PRODUCTION COSTS Fixed Costs (TFC or AFC) Total Fixed Costs Variable Costs (TVC or AVC) Total Variable Costs

Total Costs Average Total Cost = Quantity Change in Total Costs Marginal Cost = Change in Quantity SHORT-RUN PRODUCTION COSTS Total Cost (TC & ATC) Total Fixed + Total Variable Costs Marginal Cost (MC) Total Variable Costs

SHORT-RUN PRODUCTION COSTS Summary 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

Test Scores • If your current average is 86% and you scored a 73% on the most recent test, did your class average go up or down? • Down

Test Scores • Your average grade is a 64%. You scored an 82% on the marginal assignment. What happened to your average grade? • It went up.

Production • If your MP is higher than your AP then… • AP goes up. • If your MP is lower than your AP then… • AP goes down. • The same is true for MC and AVC.

AP and MP Q of Labor P Q PRODUCTIVITY AND COST CURVES AP MP MC AVC

SHORT-RUN COSTS GRAPHICALLY TC Combining TVC With TFC to get Total Cost P TVC Fixed Cost Variable Cost Total Cost TFC Q

SHORT-RUN COSTS GRAPHICALLY Plotting Average and Marginal Costs MC P ATC AVC AFC Q

Law of Diminishing Marginal Returns As more of a variable resource is added to a fixed resource, at some point, the MP of the variable resource will decline.

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

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

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

Negative Marginal Returns

SHORT-RUN COSTS GRAPHICALLY MC P ATC AVC AFC Q

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

LONG-RUN PRODUCTION COSTS P Q

LONG-RUN PRODUCTION COSTS P The long-run ATC just “envelopes” all of the short-run ATC curves. Q

LONG-RUN PRODUCTION COSTS P LRATC Q

ECONOMIES OF SCALE • Learning by Doing • Labor Specialization • Managerial Specialization • Efficient Capital • Other Factors Diseconomies of Scale Constant Returns to Scale graphically presented...

ECONOMIES AND DISECONOMIES OF SCALE P Economies of scale LRATC Q

ECONOMIES AND DISECONOMIES OF SCALE P Constant returns to scale Economies of scale LRATC Q

ECONOMIES AND DISECONOMIES OF SCALE P Constant returns to scale Diseconomies of scale Economies of scale LRATC Q

MINIMUM EFFICIENT SCALEAND INDUSTRY STRUCTURE • Minimum Efficient Scale – MES • Lowest output where you minimize cost

LONG-RUN PRODUCTION COSTS P LRATC Q

The Costs of Production