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Chapter 7: Producer Cost

Chapter 7: Producer Cost. Costs of Production. The Total Variable Cost. Curve. TVC. Y. $. Output. (Y). $. Output. (Y). $. Inflection Point. Increases at a. Decreasing Rate. Output. (Y). TVC. $. Increases. at an. Increasing Rate. Inflection Point. Increases at a.

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Chapter 7: Producer Cost

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  1. Chapter 7: Producer Cost Costs of Production

  2. The Total Variable Cost Curve TVC Y

  3. $ Output (Y)

  4. $ Output (Y)

  5. $ Inflection Point Increases at a Decreasing Rate Output (Y)

  6. TVC $ Increases at an Increasing Rate Inflection Point Increases at a Decreasing Rate Output (Y)

  7. TVC $ Increases at an Increasing Rate Inflection Point Increases at a Decreasing Rate Maximum Output Y* Output (Y)

  8. Links between TVC and the Production Function Y TVC X Y Production Function TVC Function

  9. Y Y TPP X Y $ $ Y X

  10. o Y Y 45 TPP X Y $ $ Y X

  11. o Y Y 45 TPP X Y $ $ TC=VX V=price of X V X Y X

  12. o Y Y 45 TPP X Y $ $ TC=VX V=price of X V X Y X

  13. o Y Y 45 TPP X Y $ $ TC=VX TVC V=price of X V X Y X

  14. TVC is the Mirror Image of the Production Function Now introduce Total Fixed Cost

  15. Fixed Costs Do Not Vary with output

  16. $ FC Maximum Output Y* Output (Y)

  17. TVC $ Increases at an Increasing Rate Inflection Point Increases at a Decreasing Rate FC Maximum Output Y* Output (Y)

  18. Total Cost = Total Variable Cost + (Total) Fixed Cost TC = TVC + (T)FC* *leave off the T to avoid confusion with Total FACTOR Cost

  19. TVC $ Inflection Point FC Minimum Slope of Minimum Ratio TC & TVC TVC/Y Minimum Ratio TC/Y Output (Y)

  20. TC TVC $ Inflection Point FC Minimum Slope of Minimum Ratio TVC/Y TC & TVC Minimum Ratio TC/Y Output (Y)

  21. TC TVC $ Inflection Point FC Minimum Slope of Minimum Ratio TC & TVC TVC/Y Minimum Ratio TC/Y Output (Y)

  22. TC/Y = Average Cost = AC TVC/Y =Average Variable Cost = AVC Slope of TC or Slope of TVC = Marginal Cost = MC

  23. Marginal Cost (MC) = Change in TC (or TVC) divided by Change in Output TC/ Y This is the cost of the Incremental unit of output

  24. Total Revenue (TR) = Price (P) of output times the quantity of output (Y) produced . TR= P Y

  25. Marginal Revenue (MR) = Change in Total Revenue ( TR) divided by Change in Output ( Y) TR/ Y This is the return from the incremental unit of output

  26. If the Product Price is Constant then Marginal Revenue is Constant The producer can sell as much or as little as he wants at the going market price! Farmers are Price-Takers

  27. TC TVC $ Inflection Point FC Slope of Minimum Minimum Ratio TC/Y TC & TVC Minimum Ratio TVC/Y Y $ Y

  28. TC TVC $ Inflection Point FC Slope of Minimum Ratio TC/Y Minimum TC & TVC Minimum Ratio TVC/Y Y $ AVC Y

  29. TC TVC $ Inflection Point FC Minimum Ratio TC/Y Slope of Minimum TC & TVC Minimum Ratio TVC/Y Y AC $ AVC Y

  30. TC TVC $ Inflection Point FC Minimum Ratio TC/Y Minimum Minimum Ratio Slope of TC & TVC TVC/Y Y MC AC $ AVC Y

  31. Average Fixed Cost (AFC) = Total Fixed Cost (FC) divided by Output (Y) AFC = FC/Y FC is constant As output increases: Y becomes larger and larger, and AFC becomes smaller and smaller

  32. Form a rectangle, beginning with any point on the Average Fixed Cost curve. Points A, B, and C are examples. The areas of each of the three rectangles shown are equal. The area of each of these rectangles is equal to total Fixed Cost (FC).

  33. $/Y Rectangular Hyperbola A All Rectangles Equal Area B C AFC Output (Y)

  34. $/Y Rectangular Hyperbola A All Rectangles Equal Area B C AFC Output (Y)

  35. $/Y Rectangular Hyperbola A All Rectangles Equal Area B C AFC Output (Y)

  36. $/Y Rectangular Hyperbola A All Rectangles Equal Area B C AFC Output (Y)

  37. Profit Maximization: the Output Side

  38. MC $ AC AVC MC=MR MC=MR MR = D = P Total Revenue Output Y* Profit Maximizing Output Level

  39. MC $ AC AVC MC=MR MC=MR MR = D = P Total Revenue Total Cost Output Y* Profit Maximizing Output Level

  40. MC $ AC Profit AVC MC=MR MR = D = P Output Y* Profit Maximizing Output Level

  41. Classic Rule: Profits are Maximum when Marginal Cost = Marginal Revenue MC=MR

  42. Profit Maximizing Level of Output Y where Marginal Cost = Marginal Revenue MC=MR

  43. Impacts of Changing Product Prices

  44. Assumption: The Demand Curve Faced by the Firm is Horizontal The firm can sell as much or as little as it wants at the going market price Demand is PERFECTLY ELASTIC

  45. $ MC MC=MR Profit AC AVC MR = D = P FC AFC Output Y*

  46. MC $ AC AVC MC = MR Zero Profit FC AFC Output Y*

  47. $ MC AC AVC Loss MR = D = P MC = MR Continue to Produce Since Variable Costs Are Covered FC AFC Output Y*

  48. MC $ AC AVC Loss MR=AR=D=P MC = MR Indifferent with respect to production or no production FC AFC Output Y*

  49. MC $ AC AVC MR = D = P MC = MR Better off not producing Shut-down Situation FC AFC Output

  50. These conditions apply in the Short Run In the long run all costs are variable, and all costs must be covered

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