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Economic Profit, Production and Economies of Scale

Economic Profit, Production and Economies of Scale. By the end of this Section you should be able to:. Calculate and define: 2 kinds of Profit 2 kinds of associated costs Production Total Product (TP) Marginal Product (MP) Increasing, decreasing and negative marginal returns

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Economic Profit, Production and Economies of Scale

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  1. Economic Profit, Production and Economies of Scale

  2. By the end of this Section you should be able to: • Calculate and define: • 2 kinds of Profit • 2 kinds of associated costs • Production • Total Product (TP) • Marginal Product (MP) • Increasing, decreasing and negative marginal returns • Discuss and apply the Law of Diminishing Marginal Product • Average Product (AP)

  3. Profit • Firm’s main goal is to maximize profit. • Profit is defined as Total Revenue (TR) minus Total Cost (TC). • TR=price*quantity=PQ • TC – we will talk about this in the next section

  4. Costs • There exists two types of costs: • Explicit Cost: A Cost paid in Money. • Implicit Cost: Expenses an owner does not have to pay out of pocket, such as Opportunity Cost, Owner Provided Capital (K), and Owner Provided Labor (L). • These two types of costs yield 2 types of Profits.

  5. Types of Profit • Accounting Profit: looks at revenue as money taken in and costs as the money it takes to produce things. • Defines Total Costs as explicit costs. • Economic Profit: looks at revenue as money taken in and costs as the money it takes to produce things and expenses an owner does not payout of pocket. • Defines Total Costs as explicit and implicit costs.

  6. Example of Types of Profit • Suppose Sam owns a smoothie shop: • TR: $150,000 • Explicit Costs: • Cost of fruit and yogurt: $20,000 • Cost of wages: $22,000 • Implicit Costs: • Sam’s forgone wages (owning a smoothie shop and not working somewhere else): $34,000 • Accounting Profit: • TR – EC = 150,000-20,000-22,000 = 108,000 • Economic Profit: • TR – EC – IC = 150,000-42,000-34,000 = 74,000

  7. Production • The relationship between output and quantity of labor is described by total product, marginal product and average product.

  8. Total Product • Total Product is the total quantity of a good provided in a given period. • It defines the total amount that can be produced in a period of time given the number of workers. • So we look at production possibilities with a set number of workers.

  9. Marginal Product • Marginal Product is the change in total product due to a one unit increase in the amount of labor employed. • MP= TP Labor Increasing Marginal Returns Gallons per Additional Worker Decreasing Marginal Returns 0 Negative Marginal Returns Quantity of Labor So we look at how the total product changes while the amount of labor changes.

  10. Increasing Marginal Returns • Increasing Marginal Returns is when the marginal product of an additional worker exceeds the marginal product of the previous worker. • When there are few workers, they can’t get everything done. As you hire more workers, the work gets done (there is an increase in quantity produced). • As the number of workers increases, the total amount produced increases and the production per worker increases too.

  11. Decreasing Marginal Returns • Decreasing Marginal Returns is when the marginal product of an additional worker is less than the marginal product (MP) of the previous worker. • Each additional worker is not helping as much as the previous worker, but they do help and positively increase output. • As the number of workers increases, the total amount produced increases but the amount produced per worker decreases.

  12. Negative Marginal Returns • Negative Marginal Returns is when an additional person decreases the amount of quantity produced. • Too many cooks in the Kitchen, New Workers Distract, etc. • As the number of workers increases, both the amount of production decreases and the amount of production per worker decreases. • The type of return (Increasing, Decreasing or Negative) is determined by the slope of the total product line.

  13. Law of Diminishing Returns • The law of diminishing returns:as successive units of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decline. • Because there are fixed things (plant size) in the short run, increasing variable inputs such as labor will lead to diminishing returns.

  14. Average Product • Average Product (AP) is the general productivity of each worker. • AP = TP Q of Labor

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