chapter 5 the production process and costs mcgraw-hill/irwin copyright © 2014 by the mcgraw-hill...
TRANSCRIPT
CHAPTER 5
The Production Process and Costs
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline• The production function
– Short- versus long-run decisions– Measures of productivity– Manager’s role in production process– Production function and productivity algebraic forms– Isoquants and isocosts– Cost minimization and optimal input substitution
• The cost function– Short-run costs– Average and marginal costs– Relations among costs– Fixed and sunk costs– Cost function algebraic forms– Long-run costs and economies of scale
• Multiple-output cost functions– Economies of scope and cost complementarity 5-2
Chapter Overview
Introduction
• Chapter 4 focused on how consumers adjust consumption decisions in reaction to price and income changes. The theory developed illustrates the underlying principles of individual and market demand curves.
• This chapter examines how managers select the optimal mix of inputs that minimize production costs.
5-3
Chapter Overview
The Production Function
•
5-4
The Production Function
Short-Run versus Long-Run Decisions: Fixed and Variable Inputs
• Short-run– Period of time where some factors of production
(inputs) are fixed, and constrain a manager’s decisions.
• Long-run– Period of time over which all factors of production
(inputs) are variable, and can be adjusted by a manager.
5-5
The Production Function
Measures of Productivity
•
5-6
The Production Function
Measures of Productivity in Action
•
5-7
The Production Function
Relation between Productivity Measures in Action
5-8
Labor input(holding capital constant)
0
Total productAverage productMarginal product
Total product (TP)
Average product (APL)
Marginal product (MPL)
Increasing marginal returns to labor
Decreasing marginal returns to labor
Negativemarginal returns to labor
The Production Function
• Law of Diminishing Returns: As additional units of a variable input are combined with a fixed input, at some point the additional output (i.e., marginal product) starts to diminish.– Nothing says when diminishing returns will start to take
effect, only that it will happen at some point.– All inputs added to the production process are exactly the
same in individual productivity
• The Three Stages of Production in the Short Run– Stage I: From zero units of the variable input to
where AP is maximized (where MP=AP)– Stage II: From the maximum AP to where MP=0– Stage III: From where MP=0 on
• In the short run, rational firms should only be operating in Stage II.
• Why not Stage III?– Firm uses more variable inputs to produce less output
• Why not Stage I?– Underutilizing fixed capacity– Can increase output per unit by increasing the amount of the
variable input
• What level of input usage within Stage II is best for the firm?
• The answer depends upon how many units of output the firm can sell, the price of the product, and the monetary costs of employing the variable input.
The Manager’s Role in the Production Process
•
5-13
The Production Function
Manager’s Role in the Production Process in Action
•
5-14
The Production Function
Algebraic Forms of Production Functions
•
5-15
The Production Function
Algebraic Forms of Production Functions in Action
•
5-16
The Production Function
Algebraic Measures of Productivity•
5-17
The Production Function
Algebraic Measures of Productivity in Action
•
5-18
The Production Function
Isoquants and Marginal Rate of Technical Substitution
•
5-19
The Production Function
Isoquants and Marginal Rate of Technical Substitution in Action
5-20
Labor Input0
A
B
Substituting labor for capital
Increasing output
Capital Input
The Production Function
Diminishing Marginal Rate of Technical Substitution in Action
5-21
Labor Input0
D
C
Capital Input
BA
The Production Function
Isocost and Changes in Isocost Lines
•
5-22
The Production Function
Isocost Line
5-23
Labor Input0
Capital Input
The Production Function
Changes in the Isocost Line
5-24
Labor Input0
Capital Input
The Production Function
Less expensive inputbundles
More expensive inputbundles
Changes in the Isocost Line
5-25
Labor Input0
Capital Input
The Production Function
Cost-Minimization Input Rule in Action
5-26
Labor Input0
Capital Input
The Production Function
Cost Minimization and the Cost-Minimizing Input Rule
•
5-27
The Production Function
Cost-Minimizing Input Rule in Action
•
5-28
The Production Function
Optimal Input Substitution in Action
5-29
Labor Input0
B
Capital Input
New cost-minimizing point due to higher wage
A
Initial point of cost minimization
The Production Function
H
I
F
J
G
The Cost Function
•
5-30
The Cost Function
Short-Run Costs in Action
5-31
Output0
Total costsVariable costsFixed costs
The Cost Function
Average and Marginal Costs•
5-32
The Cost Function
The Relationship between Average and Marginal Costs in Action
5-33
Output0
ATC, AVC, AFC and MC ($)
Minimum of ATC
Minimum of AVC
The Cost Function
Fixed and Sunk Costs
• Fixed costs– Cost that does not change with output.
• Sunk cost– Cost that is forever lost after it has been paid.
• Principle of Irrelevance of Sunk Costs– A decision maker should ignore sunk costs to
maximize profits or minimize loses.
5-34
The Cost Function
Long-Run Costs
• In the long run, all costs are variable since a manager is free to adjust levels of all inputs.
• Long-run average cost curve– A curve that defines the minimum average cost of
producing alternative levels of output allowing for optimal selection of both fixed and variable factors of production.
5-35
The Cost Function
Long-Run Average Total Costs in Action
5-36
Output0
LRAC ($)
The Cost Function
Economies of Scale
• Economies of scale– Declining portion of the long-run average cost
curve as output increase.• Diseconomies of scale– Rising portion of the long-run average cost curve
as output increases.• Constant returns to scale– Portion of the long-run average cost curve that
remains constant as output increases.
5-37
The Cost Function
Economies and Diseconomies of Scale in Action
5-38
Output0
LRAC ($)
The Cost Function
Economies of scale Diseconomies of scale
Constant Returns to Scale in Action
5-39
Output0
LRAC ($)
The Cost Function
Multiple-Output Cost Function
•
5-40
Multiple-Output Cost Function
Multiple-Output Cost Function in Action•
5-41
Multiple-Output Cost Function
Conclusion
•
5-42
5-43
Labor Input0
Capital Input
The Production Function
Cost-Minimization In Action
Diminishing Marginal Rate of Technical Substitution in Action
5-44
Labor Input0
A
B
Capital Input
CD
The Production Function
•
5-45
The Production Function
Cost-Minimization Input Rule In Action
Multiple-Output Cost Function in Action•
5-46
Multiple-Output Cost Function