BU224: Microeconomics Unit 6 Seminar

1. BU224: MicroeconomicsUnit 6 Seminar Tutor Center: http://khe2.acrobat.com/kubc/ (Check the Business Tutor Center Link) Greg Evans, PhD

2. Unit 6 Seminar Agenda • Chapter 11: Behind the Supply Curve: Inputs and Costs • “Theory of Production and Costs” • “Production, Costs and Supply”

3. Behind the Supply Curve: Inputs and Costs • The various types of costs a firm faces • Goals: • Understand how a profit-maximizing firm chooses the optimal quantity of output • Understand the costs of production relationships between input and output

4. The Production Function • The purpose of a firm is to turn inputs into outputs • A production function is the relationship between the quantity of inputs a firm uses and the quantity of output it produces • Output = f(labor, capital, inputs, technology)

5. Inputs and Output: Short run and Long run • The short run: the time period in which at least one input is fixed. (fixed inputs + variable inputs) • The long run: the time period in which all inputs can be varied. (all inputs are variable inputs) • Short run and long run varies from firm to firm

6. Fixed Inputs vs. Variable Inputs • In the Short run a firm faces: • A fixed input is an input whose quantity is fixed for a period of time and cannot be varied • Variable inputs: resources that can change in quantity depending on the level of output being produced

7. Production and Costs • A fixed cost is a cost that does not depend on the quantity of output produced. It is the cost of the fixed input • A variable cost is a cost that depends on the quantity of output produced. It is the cost of the variable input • Cost minimization generally involves variable costs • Cost minimization leads to profit maximization

8. Total Costs of Production • The total cost (TC) of producing a given quantity of output is the sum of the fixed cost (FC) and the variable cost (VC) of producing that quantity of output • TC = FC + VC

9. Fixed, variable and total costs of production for a firm Output (Q) VC* FC TC (‘000) 0 0 $30 $30 1 $10 30 40 2 25 30 55 3 45 30 75 4 70 30 100 5 100 30 130 6 135 30 165 * VC = Labor needed to produce Q * price of labor (wage rate)

10. Average Total Cost • Average total cost (ATC) is total cost of production divided by the quantity of output produced • Total Cost/Quantity of Output • ATC = TC/Q

11. Average Total Cost (ATC) Output (Q) TC (VC+FC) ATC (TC/Q) 0 $30 -- 1 40 40 2 55 27.5 3 75 25 4 100 25 5 130 26 6 165 27.5

12. Profit maximization and the output decision • The rule for determining whether a firm is profitable depends on a comparison of the peer unit market price (P) or the marginal revenue of the good to the firm’s break even price • If P>ATC, the firm earns a profit • If P=ATC, the firm breaks even • If P<ATC, the firm incurs a loss • A firm’s break even price: minimum average total cost (ATC) • Minimum-cost output: it is the quantity of output level where the firm incurs the lowest ATC • Note the output levels of 3 and 4 with ATC=$25 in table

13. Average Fixed Cost & Average Variable Cost • Average fixed cost: fixed cost per unit of output • Fixed Cost / Quantity of Output • AFC = FC/Q • Average variable cost: variable cost per unit of output • Variable Cost / Quantity of Output • AVC = VC/Q

14. Average Fixed Cost (AFC) Output FC AFC (FC/Q) 0 $30 -- 1 30 30 2 30 15 3 30 10 4 30 7.5 5 30 6 6 30 5

15. Average Variable Cost Output VC AVC (VC/Q) 0 0 -- 1 $10 10 2 25 12.5 3 45 15 4 70 17.5 5 100 20 6 135 22.5

16. Various Costs of the Firm Q VC FC TC AVC AFC ATC 0 0 $30 $30 -- -- -- 1 $10 30 40 10 30 40 2 25 30 55 12.5 15 27.5 3 45 30 75 15 10 25 4 70 30 100 17.5 7.5 25 5 100 30 130 20 6 26 6 135 30 165 22.5 5 27.5

17. Marginal Cost of Production • Change in total cost of production for a one unit increase in production quantity • Change in Total Cost / Change in Quantity

18. Computing Marginal Cost of Production Q TC MC 0 $30 -- 1 40 10 2 55 15 3 75 20 4 100 25 5 130 30 6 165 35

19. Questions???