chapter 7copyright ©2010 by south-western, a division of cengage learning. all rights reserved 1...
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 1
ECON
Designed byAmy McGuire, B-books, Ltd.
McEachern 2010-2011
7CHAPTERProduction and Cost in the Firm
Micro
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 2
LO1
Cost and Profit
Producers: Maximize profit Opportunity cost
– All resources have an opportunity cost Explicit costs
– Payments for resources Implicit costs
– Opportunity cost of resources owned by the firm / firm owners
– No cash payment
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 3
LO1
Alternative Measures of Profit
Accounting profit– Total revenue minus explicit costs
Economic profit– Total revenue minus all costs (implicit and
explicit)• Opportunity cost of all resources
Normal profit– “Accounting profit in excess of normal profit”
• Accounting profit = Economic + Normal profit
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 4
LO1 Wheeler Dealer Accounts, 2010
Exhibit 1
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 5
LO2
Production in the Short Run
Variable resources– Can be varied quickly
Fixed resources – Cannot be altered easily
Short run– At least one resource is fixed
Long run – No resource is fixed
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 6
LO2
Law of Diminishing Marginal Returns
Total product Production function
– Relationship between amount of resources employed and total product
Marginal product– Change in total product from an
additional unit of resource
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 7
LO2
Law of Diminishing Marginal Returns
Increasing marginal returns– Marginal product
increases Diminishing marginal
returns – Marginal product
decreases Law of diminishing
marginal returns
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 8
LO2
The Short-Run Relationship Between Units of Labor and Tons of Furniture Moved
Marginal product increases as the firm hires each of the first three workers, reflecting increasing marginal returns. Then marginal product declines, reflecting diminishing marginal returns. Adding more workers may, at some point, actually reduce total product (as occurs here with an eighth worker) because workers start getting in each other’s way.
Exhibit 2
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LO2 Effects of an Increase in Demand Exhibit 3 5
10
15T
otal
pro
duct
(to
ns/d
ay)
5 10 Workers per day0
5 10 Workers per day
1
3
5
Mar
gina
l pro
duct
(to
ns/d
ay)
0
2
4
Total
product
Marginal product
Negative
marginal
returns
Diminishing but
positive
marginal returns
Increasing
marginal
returns
(a) Total product
(b) Marginal product
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 10
Costs in the Short Run
Fixed cost FC For fixed resources
Variable cost VC For variable resources
Total cost TC = FC + VC Marginal cost MC = ∆TC/∆q
Change in TC to produce one more unit of output
LO3
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 11
Costs in the Short Run
Changes in MC Reflect changes in
marginal productivity Increasing marginal returns
MC falls Diminishing marginal
returns MC increases
LO3
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LO3
Short-Run Total and Marginal Cost Data for Smoother Mover
First 3 workers: increasing marginal returns: MC declines
With the 4th worker: diminishing marginal returns: MC increases
Exhibit 4
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 13
LO3
Total and Marginal Cost
Curves for Smoother
Mover
FC = $200 at all levels of output
VC starts from origin; increases slowly at first; with diminishing returns, VC increases rapidly
TC is the vertical sum of FC and VC
MC first declines: increasing marginal returns; then increases: diminishing marginal returns
Exhibit 5
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Average Cost in the Short Run
Average variable cost AVC = VC/q Average total cost ATC = TC/q When MC < average cost
The marginal pulls down the average When MC > average cost
The marginal pulls up the average U-shape of average cost curves
Law of diminishing marginal returns
LO3
$
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 15
LO3
Short-Run Total, Marginal, and Average Cost Data for Smoother Mover
MC first falls then increases (increasing then diminishing marginal returns)As long as MC < AC, average cost declinesOnce MC > AC, average cost increases
Exhibit 6
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 16
LO3
Average and Marginal Cost Curves for Smoother Mover
ATC and AVC: decline,
reach low points, then rise.
When MC is below AVC (ATC), AVC (ATC) is falling
When MC = AVC (ATC), AVC (ATC) is at its minimum.
When MC is above AVC (ATC),
AVC (ATC) is increasing.
Exhibit 7
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 17
Costs in the Long Run
LO4
All resources can be varied Planning horizon Firms plan in the long run Firms produce in short run
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Costs in the Long Run
LO4
U-shaped long-run average cost curve Economies of scale
– LRAC falls as output expands Diseconomies of scale
– LRAC increases as output expands Constant lung-run average cost
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LO4
Short-Run Average Total Cost Curves Form the Long-Run Average Cost Curve, or Planning
Curve
Exhibit 8
Cos
t pe
r un
it
0 q qa q’ Output per periodqb
S
S’
M M’
L
L’SS’, MM’, LL’ are short run ATC curves
Long run ATC curve: SabL’
a b
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 20
LO4
Many Short-Run ATC Curves Form a Firm’s LRAC Curve, or Planning Curve
ATC1
ATC2
0 q q’ Output per period
Many possible plant sizes
Cos
t pe
r un
it
$11
10
9
b
ATC3
ATC4
ATC5
ATC6
ATC7
ATC8
ATC9
ATC10
Long-run
average cost
c
a
Each short-run curve is
tangent to the long run
average cost curve
Each point of tangency represents the least cost way of producing that level of output
Exhibit 9
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 21
LO4
A Firm’s Long-Run Average Cost Curve
Cos
t pe
r un
it
0 A Output per periodB
Economies
of scale
Long-run
average cost
Diseconomies
of scale
Constant
average cost
Exhibit 10
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 22
LO4C
ase
Stu
dy
Scale Economies and Diseconomies at the Movies
Movie theaters Economies of scale
Decrease in LRAC as the number of screens initially increases
Diseconomies of scale Adding even more screens Problems arise LRAC starts to increase
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 23
Economies and Diseconomies of Scale
LO4
Plant level– Particular location
Firm level– Collection of plants
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 24
LO4C
ase
Stu
dy
Scale Economies and Diseconomies at McDonald's
Economies of scale At plant level
Specialization At firm level
Sharing: information; technology Diseconomies
of scale At firm level
Uniform
menu
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A Closer Look at Production and Cost
Ap
pen
dix Production function
Technologically efficient production Isoquant
– All technologically efficient combinations of 2 resources
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 26
A Firm’s Production Function Using Labor and Capital: Production per Month
Exhibit A
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 27
A Closer Look at Production and Cost
Ap
pen
dix Isoquants
– Farther from origin: greater output rates– Negative slope– Don’t intersect– Convex to the origin
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 28
A Closer Look at Production and Cost
Ap
pen
dix Marginal rate of technical substitution
– MRTS– Slope of isoquant
– MRTS = MPL/MPC
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 29
A Firm’s Isoquants
Exhibit B
0 5Units of labor per month
10
Uni
ts o
f ca
pita
l per
mon
th
5
10
Q1 (290)
Q2 (415)
Q3 (475)
a
b
cd
e
hf
g
Q1: all technologically efficient combinations of labor and capital
that can be used to produce 290 units of output
Q2: 415 units of output
Q3: 475 units of output
Isoquants:
- negative slope
- convex to the origin
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 30
A Closer Look at Production and Cost
Ap
pen
dix Isocost line
All combinations of capital and labor Can be hired for a given total cost Are parallel Slope of isocost line
– Negative – Price of labor divided by price of capital
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 31
A Firm’s Isocost Lines
Exhibit C
5 10 150
Units of labor per month
5
10
Uni
ts o
f ca
pita
l per
mon
th
TC = $15,000
TC = $19,000
TC = $22,500
Slope = -w/r = -$1,500/$2,500 = -0.6
Each isocost line– Combinations of labor and
capital that can be purchased for a given amount of total cost
– Slope is negative wage divided by the rental cost of capital
Higher costs: isocost lines farther from origin
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 32
A Closer Look at Production and Cost
Ap
pen
dix Profit maximization
Cost minimization Minimum cost to produce a given output
– Tangency between isocost line and isoquant
• Slope = MRTS = w/r Expansion path
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 33
A Firm’s Optimal Combination of Inputs
Exhibit D
Q1 (290)
Q2 (415)
Q3 (475)
f
5 100
Units of labor per month
5
10
Uni
ts o
f ca
pita
l per
mon
th
TC = $19,000
a
e
e: isoquant Q2 is tangent
to the isocost line
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Chapter 7 Copyright ©2010 by South-Western, a division of Cengage Learning. All rights reserved 34
A Firm’s Expansion PathExhibit E
Expansion path
Q2
L L’0
Units of labor per month
C
Uni
ts o
f ca
pita
l per
mon
th
Q4
Q3
Q1
d
h
TC3
TC2
TC1
TC4
ab
c
Expansion path- Slopes up to the right- More of both
resources is needed to increase output