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Unit III: Costs of Production and Perfect Competition. Accountants vs. Economists. Accountants look at only EXPLICIT COSTS Explicit costs (out of pocket costs) are payments paid by firms for using the resources of others. Example: Rent, Wages, Materials, Electricity Bills.
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Accountants vs. Economists • Accountants look at only EXPLICIT COSTS • Explicit costs (out of pocket costs) are payments paid by firms for using the resources of others. • Example: Rent, Wages, Materials, Electricity Bills • Economists examine both the EXPLICIT COSTS and the IMPLICIT COSTS • Implicit costs are the opportunity costs that firms “pay” for using their own resources • Example: Forgone Wage, Forgone Rent, Time
Inputs and Outputs Change in Total Product Marginal Product = Change in Inputs • To earn profit, firms must make products (output) • Inputs (FACTORS) are the resources used to make outputs. • Total Physical Product (TP)- total output or quantity produced • Marginal Product (MP)- the additional output generated by additional inputs (workers).
Inputs and Outputs Change in Total Product Marginal Product = Change in Labor Input Total Product Average Product = Units of Labor • To earn profit, firms must make something (output) • Inputs are the resources used to produce outputs. • Input resources are also called FACTORS. • Total Physical Product (TP)- total output or quantity produced What is the general relationship between inputs and outputs? • Marginal Product (MP)- the additional output generated by additional inputs. • Average Product (AP)- the output per unit of input
Calculate the MP, identify the three stages, and explain why each stage occurs
Calculate the MP, identify the three stages, and explain why each stage occurs
Calculate the MP, identify the three stages, and explain why each stage occurs
Why does MP start to fall? The Law of Diminishing Marginal Returns As successive units of variable resources (workers) are added to fixed resources (machinery, tool, etc.), the additional output produced from each new worker will eventually fall. Too many cooks in the kitchen!
Law of Diminishing Returns There are three stages of returns. Total Product Total Product, TP Stage I: Increasing Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Quantity of Labor Marginal Product
Law of Diminishing Returns There are three stages of returns. Total Product Total Product, TP Stage II: Diminishing Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Quantity of Labor Marginal Product
Law of Diminishing Returns There are three stages of returns. Total Product Total Product, TP Stage III: Negative Marginal Returns Quantity of Labor Average Product, AP, and Marginal Product, MP Average Product Quantity of Labor Marginal Product
Fixed Costs Average Fixed Costs = Quantity Variable Costs Average Variable Costs = Quantity Definitions Fixed Costs Fixed costs (costs for fixed resources) DON’T change with the amount produced Ex: Rent, Insurance, Managers salaries, etc. Variable Costs Variable costs (costs for variable resources) change as more or less is produced Ex: raw materials, labor, electricity, etc.
Total Costs Average Total Cost = Quantity Change in Total Costs Marginal Cost = Change in Quantity Definitions Total Cost Sum of Fixed and Variable Costs Marginal Cost Additional costs of and additional output. Ex: If the production of another output increases total cost from $100 to $120, the MC is $20.
Per-Unit Costs (Average and Marginal) ATC and AVC get closer and closer but NEVER touch MC 12 11 10 9 8 7 6 5 4 3 2 1 ATC AVC Costs (dollars) Average Fixed Cost AFC 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Quantity
Converting Average to Total At output Q, what area represents: TC VC FC 0CDQ 0BEQ 0AFQ or BCDE
MC 12 11 10 9 8 7 6 5 4 3 2 1 Why is the MC curve U-shaped? Costs (dollars) 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Quantity
Why is the MC curve U-shaped? • The MC curve falls and then rises because of diminishing marginal returns • The additional cost of the first units produced fall when workers have increasing marginal returns. • As production continues, each worker adds less and less to production so the marginal cost for each unit increases.
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Shifting Costs Curves What if Fixed Costs increase to $200
Shifting Costs Curves Which Per Unit Cost Curves Change?
Shifting Costs Curves ONLY AFC and ATC Increase!
Shifting Costs Curves ONLY AFC and ATC Increase!
Shifting Costs Curves If fixed costs change ONLY AFC and ATC Change! MC and AVC DON’T change!
Shift from an increase in a Fixed Cost MC ATC1 ATC AVC Costs (dollars) AFC1 AFC Quantity
Shift from an increase in a Fixed Cost MC ATC1 AVC Costs (dollars) AFC1 Quantity
Shifting Costs Curves What if the cost for variable resources increase
Shifting Costs Curves Which Per Unit Cost Curves Change?
Shifting Costs Curves MC, AVC, and ATC Change!
Shifting Costs Curves MC, AVC, and ATC Change!
Shifting Costs Curves If variable costs change MC, AVC, and ATC Change!
Shift from an increase in a Variable Costs MC1 MC ATC1 AVC1 ATC AVC Costs (dollars) AFC Quantity
Shift from an increase in a Variable Costs MC1 ATC1 AVC1 Costs (dollars) AFC Quantity
Short-Run vs. Long-Run • The short-run is a period in which at least one resource is fixed. • Plant capacity/size is NOT changeable • In the long-run ALL resources are variable • NO fixed resources • Plant capacity/size is changeable
Long Run ATC • What happens to the average total costs of a product when a firm increases its plant capacity? • Example of various plant sizes: • I make looms out of my garage with one saw • I rent out building, buy 5 saws, hire 3 workers • I rent a factory, buy 20 saws and hire 40 workers • I build my own plant and use robots to build looms. • I create plants in every major city in the U.S. • Long Run ATC curve is made up of all the different short run ATC curves of various plant sizes.
Long Run ATC 5 Various Plant Capacities Unit Costs Output
