economics for managers gtu mba sem 1 chapter 13
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7/31/2019 Economics For Managers GTU MBA Sem 1 Chapter 13
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A Firms Total Revenue and
Total Cost
xTotal Revenuex The amount that the firm receives for
the sale of its output.
xTotal Costx The amount that the firm pays to buy
inputs.
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A Firms Profit
Profit is the firms total revenue minus
its total cost.
Profit = Total revenue - Total cost
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Costs as Opportunity Costs
A firms cost of productionincludes all the opportunity
costs of making its output of
goods and services.
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Explicit and Implicit Costs
A firms cost of production include
explicit costs and implicit costs.xExplicit costs involve a direct money
outlay for factors of production.
xImplicit costs do not involve a directmoney outlay.
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Economic Profit versus Accounting Profit
x Economists measure a firms economic profitas total revenue minus all the opportunity costs(explicit and implicit).
x Accountants measure the accounting profit as
the firms total revenue minus only the firmsexplicit costs. In other words, they ignore theimplicit costs.
x When total revenue exceeds both explicit andimplicit costs, the firm earns economicprofit.x Economic profit is smaller than accounting
profit.
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Economic Profit versus
Accounting Profit
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The Production Function
The production function shows therelationship between quantity of
inputs used to make a good and
the quantity of output of thatgood.
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Marginal Product
sThe marginal product of any
input in the production process is
the increase in the quantity of
output obtained from an additional
unit of that input.
Additional input
Additional output=Marginalproduct
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Diminishing Marginal Product
xDiminishing marginal product is the
property whereby the marginal product of an
input declines as the quantity of the input
increases.
xExample: As more and more workers are
hired at a firm, each additional worker
contributes less and less to production because
the firm has a limited amount of equipment.
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A Production Function...
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0 1 2 3 4 5
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Diminishing Marginal Product
xThe slope of the production function
measures the marginal product of
an input, such as a worker.
xWhen the marginal product
declines, the production functionbecomes flatter.
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From the Production Function to
the Total-Cost Curve
xThe relationship between the
quantity a firm can produce and itscosts determines pricing decisions.
xThe total-cost curve shows this
relationship graphically.
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Total-Cost Curve...
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Fixed and Variable Costs
xFixed costs are those costs that do not
vary with the quantity of output
produced.
xVariable costs are those costs that do
change as the firm alters the quantityof output produced.
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Family of Total Costs
xTotal Fixed Costs (TFC)
xTotal Variable Costs (TVC)xTotal Costs (TC)
TC = TFC + TVC
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Family of Total Costs
Quantity Total Cost Fixed Cost Variable Cost
0 $ 3.00 $3.00 $ 0.001 3.30 3.00 0.302 3.80 3.00 0.803 4.50 3.00 1.504 5.40 3.00 2.405 6.50 3.00 3.50
6 7.80 3.00 4.807 9.30 3.00 6.308 11.00 3.00 8.009 12.90 3.00 9.90
10 15.00 3.00 12.00
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Average Costs
xAverage costs can be determined by
dividing the firms costs by the
quantity of output produced.
xThe average cost is the cost of each
typical unit of product.
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Family of Average Costs
xAverage Fixed Costs (AFC)
xAverage Variable Costs (AVC)
xAverage Total Costs (ATC)
ATC = AFC + AVC
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Family of Average Costs
AFC =Fixed cost
Quantity=
FC
Q
AVC =Variable cost
Quantity=
VC
Q
ATC =Total cost
Quantity=
TC
Q
AFC =Fixed cost
Quantity=
FC
Q
AVC =Variable cost
Quantity=
VC
Q
ATC =Total cost
Quantity=
TC
Q
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$3.00
Family of Average Costs
Quantity AFC AVC ATC0 1 $0.30 $3.302 1.50 0.40 1.90
3 1.00 0.50 1.504 0.75 0.60 1.355 0.60 0.70 1.306 0.50 0.80 1.307 0.43 0.90 1.338 0.38 1.00 1.389 0.33 1.10 1.43
10 0.30 1.20 1.50
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Marginal Cost
xMarginal cost (MC) measures the
amount total cost rises when the firm
increases production by one unit.xMarginal cost helps answer the
following question:
x How much does it cost to produce anadditional unit of output?
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Marginal Cost
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Marginal Cost
Quantity TotalCost
MarginalCost
Quantity TotalCost
MarginalCost
0 $3.00 1 3.30 $0.30 6 $7.80 $1.30
2 3.80 0.50 7 9.30 1.50
3 4.50 0.70 8 11.00 1.70
4 5.40 0.90 9 12.90 1.905 6.50 1.10 10 15.00 2.10
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Total-Cost Curve...
Quantity of Output
(glasses of lemonade per hour)
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Average-Cost and Marginal-Cost
Curves...
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Cost Curves and Their Shapes
Marginal cost rises with the
amount of output produced.xThis reflects the property of
diminishing marginal product.
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Cost Curves and Their Shapes
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Cost Curves and Their Shapes
The average total-cost curve is U-shaped.
x At very low levels of output average total cost is
high because fixed cost is spread over only a fewunits.
x Average total cost declines as output increases.
x
Average total cost starts rising because averagevariable cost rises substantially.
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Cost Curves and Their Shapes
The bottom of the U-shape occurs at
the quantity that minimizes average
total cost. This quantity is sometimes
called the efficient scale of the firm.
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Cost Curves and Their Shapes
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Relationship Between Marginal
Cost and Average Total Cost
xWhenever marginal cost is less than
average total cost, average total cost
is falling.
xWhenever marginal cost is greater
than average total cost, average totalcost is rising.
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Relationship Between Marginal
Cost and Average Total Cost
The marginal-cost curve crosses
the average-total-cost curve at
the efficient scale.
x
Efficient scale is the quantitythat minimizes average total cost.
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Relationship Between Marginal
Cost and Average Total Cost
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The Various Measures of Cost
It is now time to examine therelationships that exist between the
different measures of cost.
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Three Important Properties of
Cost Curves
xMarginal cost eventually rises with
the quantity of output.
xThe average-total-cost curve is U-
shaped.
x
The marginal-cost curve crosses theaverage-total-cost curve at the
minimum of average total cost.
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Costs in the Long Run
xFor many firms, the division of total
costs between fixed and variable costs
depends on the time horizon beingconsidered.
x In the short run some costs are fixed.
x
In the long run fixed costs become variablecosts.
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Costs in the Long Run
Because many costs are fixed in
the short run but variable in the
long run, a firms long-run cost
curves differ from its short-run
cost curves.
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Average Total Cost in the Short
and Long Runs...
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Economies and Diseconomies
of Scale
x Economies of scale occur when long-run
average total cost declines as output
increases.
x Diseconomies of scale occur when long-
run average total cost rises as output
increases.
x Constant returns to scale occur when
long-run average total cost does not
vary as output increases.
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