1 / 32

Chapter 5

Chapter 5. Production and Cost. Production. Business firm – an organization Owned and operated by private individuals Specializes in production Production Process of combining inputs to make goods and services Technology Method of combining inputs to produce goods or services.

allegra-macias
Download Presentation

Chapter 5

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 5 Production and Cost

  2. Production • Business firm – an organization • Owned and operated by private individuals • Specializes in production • Production • Process of combining inputs to make goods and services • Technology • Method of combining inputs to produce goods or services

  3. The Production Function • Indicates the maximum amount of output a firm can produce over some period of time from each combination of inputs • Figure 1 The Firm’s Production Function Different Combinations of Inputs Different Quantities of Output Production Function

  4. Short-Run versus Long-Run Decisions • Long run • A time horizon long enough for a firm to vary all of its inputs • Variable inputs - can be adjusted up or down as the quantity of output changes • Short run • A time period during which at least one of the firm’s inputs is fixed • Fixed inputs - cannot be adjusted as output changes in the short run

  5. Production in the Short-Run • Total product • Maximum quantity of output that can be produced from a given combination of inputs • Marginal product of labor: MPL=ΔQ/ΔL • Additional output produced when one more worker is hired

  6. Units of Output Number of Workers 1 6 2 4 3 5 Total and Marginal Product • Figure 2 Total and Marginal Product Total Product 196 184 160 DQ from hiring fourth worker = 30 130 DQ from hiring third worker = 40 90 DQ from hiring second worker = 60 30 DQ from hiring first worker = 30 increasing marginal returns diminishing marginal returns

  7. Marginal Returns To Labor • Increasing marginal returns to labor • MPL increases as more labor is hired • Diminishing marginal returns to labor • MPL decreases as more labor is hired • Law of Diminishing Marginal Returns • As more and more of any input is added to a fixed amount of other inputs, its marginal product will eventually decline

  8. Thinking About Costs • Total cost • The opportunity cost of the owners - everything they must give up in order to produce that amount of output • Sunk cost • A cost that has been paid or must be paid, regardless of any future action being considered • Should not be considered when making decisions

  9. Explicit vs. Implicit Costs • Explicit cost • Money actually paid out for the use of inputs • Implicit cost • The cost of inputs for which there is no direct money payment

  10. Costs in the Short Run • Fixed costs • Costs of a firm’s fixed inputs • Remain constant as output changes • Variable costs • Costs of a firm’s variable inputs • Change with output

  11. Total Costs in the Short Run • Total fixed cost (TFC) • The cost of all inputs that are fixed in the short run • Total variable cost (TVC) • The cost of all variable inputs used in production • Total cost (TC=TFC+TVC) • The costs of all inputs—fixed and variable

  12. Dollars $435 375 315 255 195 135 0 30 90 130 160 184 Units of Output Total Cost Curves • Figure 3 The Firm’s Total Cost Curves TC TVC TFC TFC

  13. Average Costs • Average fixed cost (AFC=TFC/Q) • Total fixed cost divided by the quantity of output produced • Average variable cost (AVC=TVC/Q) • Cost of the variable inputs per unit of output • Average total cost (ATC=TC/Q) • Total cost per unit of output

  14. Marginal Cost • Marginal Cost (MC) • Increase in total cost from producing one more unit or output • MC curve is U-shaped • When MPL rises, MC falls • When MPL falls, MC rises. • MPL rises and then falls, MC will fall and then rise.

  15. Dollars $4 3 2 1 30 90 130 160 196 0 Units of Output Average and Marginal Costs • Figure 4 Average and Marginal Costs MC AFC ATC AVC 184

  16. Average and Marginal Costs • At low levels of output • MC - below the AVC and ATC curves • AVC and ATC slope downward • At higher levels of output • MC - above the AVC and ATC curves • AVC and ATC slope upward • U-shaped curves • MC curve will intersect the minimum points of the AVC and ATC curves

  17. Production and Cost in the Long Run • All inputs and all costs are variable • Least Cost Rule • To produce any given level of output, the firm will choose the input mix with the lowest cost • Long-run total cost (LRTC) • The cost of producing each quantity of output when the least-cost input mix is chosen in the long run

  18. Production and Cost in the Long Run • Long-run average total cost (LRATC) • The cost per unit of output • in the long run • all inputs are variable LRTC ≤ TC LRATC ≤ ATC

  19. Average Cost and Plant Size • Plant - Collection of fixed inputs at a firm’s disposal • Short run • Cannot change the plant size • Move along ATC curve • Long run • Choose among ATC curves • Can change the plant size • Produce at lowest possible ATC

  20. Dollars $4.00 3.00 2.00 1.00 30 90 130 160 184 250 300 0 196 Units of Output Graphing the LRATC Curve • Figure 5 Long-Run Average Total Cost ATC1 LRATC ATC3 ATC0 ATC2 C D B E A 175 Use 0 automated lines Use 1 automated lines Use 2 automated lines Use 3 automated lines

  21. The Shape of LRATC • Economies of scale - LRATC decreases as output increases • LRATC curve slopes downward • More likely to occur at lower levels of output • Spreading costs of Lumpy inputs • Diseconomies of scale - LRATC increases as output increases • LRATC curve slopes upward • More likely at higher output levels

  22. The Shape of LRATC • Constant returns to scale - LRATC is unchanged as output increases • LRATC curve is flat • U-shape of LRATC curve • Economies of scale at relatively low levels of output • Constant returns to scale at some intermediate levels of output • Diseconomies of scale at relatively high levels of output

  23. Dollars $8.00 6.00 4.00 2.00 200 250 The Shape Of LRATC • Figure 6 The Shape Of LRATC LRATC 0 Economies of Scale Constant Returns to Scale Diseconomies of Scale Pizzas Served per Day

  24. The Urge to Merge • Minimum efficient scale (MES) • The lowest output level at the minimum cost per unit in the long run • Mergers • Significant, unexploited economies of scale • Because the market has too many firms for each to operate near its MES

  25. 3. Other firms lose market share and end up at C Dollars $240 C 4. Price war - other firms must match the first-mover’s price; each firm ends up back at A - they suffer losses A 200 1. With market quantity demanded fixed at 60,000, and six firms of equal market share, each operates at A B LRATC 80 2. But any one firm can cut price slightly, increase market share, and operate with lower cost per unit, such as at the MES (point B) 20,000 Quantity per Month 8,000 10,000 The Urge to Merge • Figure 7 LRATC for a Typical Firm in a Merger-Prone Industry 5. Mergers to create three large firms would enable each to operate at its MES with less likelihood of price wars and losses

  26. Appendix: Isoquant Analysis • Every point on an isoquant represents an input mix that produces the same quantity of output • Isoquants slope downward • An increase in one input requires a decrease in the other input to keep total production unchanged • Higher isoquants • Greater levels of output than lower isoquants

  27. Labor (workers) A F 11 B C 5 Q=6,000 Q=4,000 3 5 Land (hectares) Appendix: An Isoquant Map • Figure A.1 An Isoquant Map Q=2,000

  28. Appendix: MRTS • Marginal rate of technical substitution • The rate at which a firm can substitute one input for another while keeping output constant • Decreases as we move rightward along an isoquant • Is the slope of the isoquant MRTS = MPN/MPL

  29. Appendix: Isocost Lines • An isocost line • all combinations of the two inputs • same total cost for the firm • Isocost lines always slope downward • To use more of one input - must use less of the other input; to keep total cost unchanged • The slope of an isocost line: PN / PL; constant • Higher isocost lines • Greater total costs for the firm

  30. Labor (workers) 20 TC=$10,000 15 TC=$7,500 10 C 9 TC=$5,000 Land (hectares) 5 7.5 10 3 Appendix: Isocost Lines • Figure A.2 Isocost Lines

  31. Appendix: The Least-Cost Input Combination • The point where an isocost line is tangent to the isoquant for that output level • MRTS=MPN/MPL=PN /PL • MPN/PN = MPL/PL • Many variable inputs • the marginal product per dollar of any input will be equal to the marginal product per dollar of any other input

  32. Labor (workers) TC=$10,000 20 15 J 10 5 C Q=4,000 TC=$5,000 Land (hectares) 5 7.5 10 Appendix: Isocost Lines Figure A.3 The Least-Cost Input Combination for a Given Output Level 20 The input combinations at J, C, and K can all be used to produce 4,000 units of output. 15 The input combination at C - where the isoquant is tangent to the isocost line, is the least expensive 10 5 K TC=$7,500

More Related