Principles of Microeconomics : Ch.13 Second Canadian Edition Chapter 13 The Costs of Production ©...

Principles of Microeconomics : Ch.13 Second Canadian Edition

Chapter 13

The Costs of Production

© 2002 by Nelson, a division of Thomson Canada Limited


Overview

Types of Costs and ProfitShort-Run Cost BehaviourLong-Run Cost Behaviour


Supply

The Costs of ProductionThe Law of Supply:

Firms are willing to produce and sell a greater quantity of a good when

the price of a good is high, due

to typical productivity and cost behaviour.

P

Q


Why Study Behaviour of Firms?

Gain a better understanding of the decisions made by producers.

Study how the behaviour of a firm depends on the structure of the market.


Purpose Facing The Typical Firm

The economic purpose of the firm is to maximize profit!

Profit = Total Revenue - Total Cost.


An Individual Firm’s Profit: Revenue minus Cost

Revenue: The amount that the firm receives for the sale of its product.

(Market Price x Amount Sold)= RevenueCost: The amount that the firm sacrifices to

buy inputs.Profit: Total revenue minus total costs.


Costs of Production In general, three costs are often considered

when making business supply decisions.

Explicit Costs

Implicit Costs

Sunk Costs


Costs as Opportunity CostsThe firm’s costs include Explicit Costs and

Implicit Costs:

– Explicit Costs: costs that involve a direct money outlay for factors of production.

– Implicit Costs: costs that do not involve a direct money outlay (e.g. opportunity costs of the owner’s own inputs used - implicit wages, implicit rent, cost of capital).


Costs as Opportunity Costs

Accountants measure the explicit costs but often ignore the implicit costs.

Economists include all opportunity costs when measuring costs.

Accounting Profit = TR - Explicit CostsEconomic Profit = TR - Explicit Costs -

Implicit Costs


Costs as Opportunity CostsA third, not so obvious implicit cost

includes sunk costs.Sunk costs are costs that have already

been committed and cannot be recovered. Sunk Costs are . . .

– an opportunity cost

– often ignored when making decisions about supplying a product


Quick Quiz“A farmer has planted corn seeds but

has not yet fertilized the field.” Is the cost of seed an opportunity cost

or a sunk cost?Is the cost of fertilizer an opportunity

cost or a sunk cost?Which of these two costs is more

likely to affect the decision to continue farming?


Overview



Short-Run vs. Long-RunTwo different time horizons are important when analyzing costs. Short-Run: Time period over which some inputs are variable (labour, materials) and some inputs are fixed (plant size).Long-Run: Time period over which all inputs are variable, including plant size.


Short-Run Costs

Costs of production may be divided into two categories in the short-run:Fixed Costs:

–Those costs that do not vary with the amount of output produced.

Variable Costs:

–Those costs that do vary with the amount of output produced.


Family of Total Costs...

Total Fixed Costs (TFC)Total Variable Costs (TVC)Total Costs (TC)

where: TC = TFC + TVC


Family of Average Costs. . .

Average Costs: Specific Cost / Output LevelAverage Fixed Costs (AFC) = TFC / QAverage Variable Costs (AVC) = TVC / QAverage Total Costs (ATC) = TC / Q


Marginal Cost: “How much does it cost to produce an

additional unit of output?”Marginal Cost (MC):

“The extra or additional cost of producing one more unit of output.”

MC is the addition to the cost of production that must be covered by additional revenue for profit maximization.

MC = TC ÷ Q


Quick Quiz! If Ford’s total cost of

producing 4 cars is $225,000 and its total cost of producing 5 cars is $250,000. . .

...what is the average total cost and marginal cost of producing the fifth car?


The Shape of Short-Run Cost Curves

Short-run cost behaviour is based on the productivity of the inputs (resources).

As the firm continues to expand output,in a fixed plant-size situation, eventuallythe marginal product of each successive worker hired will decrease.

The diminishing marginal product causesthe marginal cost to increase in the short-run. This in turn affects the behaviour of average total cost.


The Shape of Typical Cost CurvesC

ost

($’

s)

Quantity of output

MC



ost

($’

s)

Quantity of output

MCATC



ost

($’

s)

Quantity of output

MCATC

AVC



ost

($’

s)

Quantity of output

MCATC

AVC

AFC


The Shape of Typical Cost Curves

U-Shaped Average Total Cost (ATC):

– At low levels of output, as the firm expands production, ATC declines.

– At higher production levels, as output is increased, ATC increases.

– The bottom of the U-Shape occurs at the quantity that minimizes average total cost.

– This is called the Efficient Size of the firm.


The Relationship Between Marginal Cost and Average Total Cost

Why is ATC U - shaped?When marginal cost is less than average

total cost, average total cost is falling.

MC < ATC ATC When marginal cost is greater than average

total cost, average total cost is rising.

MC > ATC ATC



The marginal-cost curve crosses the

average-total-cost at minimum ATC.

Why?



Co

st (

$’s)

Quantity

MCATC

The marginal cost curve always crossesthe average total costcurve at the minimum

average total cost!


Overview



Long-Run CostsHow do per unit costs behave as the firm

expands all inputs, even plant size or scale of operation?

The Long-Run Average Total Cost (LRATC) reflects the lowest possible unit cost related to different plant sizes and/or scales of operation.

The LRATC Curve is U-shaped as shown in the next slide.


Long-Run Costs

Econ.of Scale

Disecon. of Scale

Constant Returns to Scale

LRATC Curve

$ PerUnit

Scale of Operation (Q)


Long-Run Costs

There are three typical long-run cost situations:Economies of Scale: LRATC decreases as the scale of operation increases.Diseconomies of Scale: LRATC increases with the scale of operation.Constant Returns to Scale: LRATC stays constant as the scale of operation increases.


Long-Run CostsPossible causes of Economies of Scale:

– volume discounts on purchases– manufacturing, warehousing,

transportation, and promotional economies

– larger firm can borrow at lower interest rates

Possible causes of Diseconomies of Scale

– management diseconomies...


Overview


Date post:	04-Jan-2016
Category:	Documents
Upload:	donald-hood
View:	220 times
Download:	0 times

Principles of Microeconomics : Ch.13 Second Canadian Edition Chapter 13 The Costs of Production ©...

Documents