chapter 8 production and costs
DESCRIPTION
Chapter 8 Production and Costs. Marginal Physical Product (MPP). What is the variable input? What is the variable cost?. So…. As more labor (VARIABLE INPUT) are added to land (FIXED INPUT) the variable inputs would yield smaller and smaller additions to output. Marginal Physical Product. - PowerPoint PPT PresentationTRANSCRIPT
Chapter 8
Production and Costs
Chapter 8
Production and Costs
Marginal Physical Product (MPP)Marginal Physical Product (MPP)
• What is the variable input?
• What is the variable cost?
L
Q
labor
outputMPPl
So…So…
• As more labor (VARIABLE INPUT) are added to land (FIXED INPUT) the variable inputs would yield smaller and smaller additions to output
Marginal Physical ProductMarginal Physical Product
a
Part (a)
(1)VARIABLEINPUT,LABOR(workers )
(2)FIXEDINPUT,CAPITAL(units )
(4)MARGINALPHYSICALPRODUCT OFVARIABLEINPUT (units )(3)(1)
(3)QUANTITY OFOUTPUT, Q(units )
0
1
2
3
4
5
6
7
1
1
1
1
1
1
1
1
0
18
37
57
76
94
111
127
18
19
20
19
18
17
16
Marginal Phys ical Product
10 2 3 4 5 6 7Number of Workers
20
19
18
17
16MP
Crowding ProblemCrowding Problem
• The point at which MPP declines
• Shows the law of diminishing returns
Average Physical ProductivityAverage Physical Productivity
• Output divided by Inputs (usually labor)
• Good for comparing firms or countries.L
QAPP
So find that…So find that…
• MC and MPP are related
• What is the relationship?
MCMPP
MCMPP
In –class
exercise
10
Does MPP sh
ow Dim
inishing
Returns??
?
Law of Diminishing Marginal Returns Law of Diminishing Marginal Returns
a
(1)VARIABLEINPUT,LABOR(Workers )
(2)FIXEDINPUT,CAPITAL(units )
(4)MARGINAL PHYSICALPRODUCT OF VARIABLEINPUT (units )(3)(1)
(3)QUANTITY OFOUTPUT, Q(units )
0
1
2
3
4
5
6
7
8
9
10
1
1
1
1
1
1
1
1
1
1
1
0
18
37
57
76
94
111
127
137
133
125
18
19
20
19
18
17
16
10
– 4
– 8
Marginal Cost Marginal Cost
a
Part (b)
(5)TOTALFIXEDCOST(dollars )
(6)TOTALVARIABLECOST(dollars )
(7)TOTALCOST(dollars )(5) + (6)
(8)MARGINALCOST(dollars )(7)(3)or(6)(3)
$40
40
40
40
40
40
40
40
$ 0
20
40
60
80
100
120
140
$40
60
80
100
120
140
160
180
$1.11
$1.05
$1.00
$1.05
$1.11
$1.17
$1.25
Marginal Cos t (dollars )
0 18 37 57 76 111 127
Quantity of Output
1.00
1.05
1.11
1.17
1.25
94
MC
Does this relationship make sense?Does this relationship make sense?
• Yes..
• If productivity increases what would happen to costs??– Decrease (MPP increase & MC decrease)
• Productivity decreases??– Increase (MPP decreases & MC increases)
MPP determines shape of MCMPP determines shape of MC
• MPP must have a declining part because of diminishing returns
• Can also define MC as:
MPP
wageMC
In-class exercise 11
How do we calculate these costs??
Give two ways to get to the cost…
Average-Marginal Rule
• Can use to see what the ATC and AVC curve look like
• Tells us what happens when MC is above or below the “average” curves
• If MC is above AVC and ATC– AVC and ATC are rising
• If MC is below AVC and ATC– AVC and ATC are falling
From Average-Marginal Rule can infer…
• MC intersects the AVC and ATC curves at their MINIMUM POINTS
• Cannot infer anything about AFC
Average and Marginal Cost Curves Average and Marginal Cost Curves
a
Cos t
Quantity of Output
Region1
Region2
0
MC ATC
L
Part (b)
Average and Marginal Cost Curves Average and Marginal Cost Curves
a
Cos t
Quantity of Output
Region1
Region2
0
MC
AVC
L
Part (a)
So…
• MC gains it shape from???– MPP and law of diminishing marginal returns
• MC below ATC: What is ATC curve doing?– Falling
• MC above ATC: What is ATC curve doing?– Rising
Average and Marginal Cost Curves Average and Marginal Cost Curves
a
Cos t
Quantity of Output0
MC
AVC
Part (c )
ATC
AFC
MC curve cutsboth AVC andATC curves at
the ir res pectivelow points .
Tying Products to CostsTying Products to Costs
A CLOSER LOOK
Production in theshort run: at
least one fixed input
MPPVariable Input
MC
MC
When MC is belowATC, AVC
When MC is aboveATC, AVC
MPP Variable Input
Now switching to the Long Run
• When does Long Run start?– As soon as all inputs (costs) are VARIABLE– No fixed costs
• Important curves– LRTC– LRATC– LRMC
Short Run vs. Long Run
• Short Run assumes FIXED plant size
• Each plant size has a unique ATC curve associated with it– SRATC
• LRATC combines all the SRATC curves
• Which points of the SRATC???
• Minimum points
Why minimum?
• LRATC shows the lowest average cost at which a firm can produce any given level of output
• LRATC is the lower ENVELOPE of the SRATC curves
• Called envelope curve
Long-Run Average Total Cost Curve (LRATC)
Long-Run Average Total Cost Curve (LRATC)
a
Average Cos t (dollars )
Quantity of Output
6
5
0
B
A
D
C
SRATC1
SRATC2 SRATC3
Q1 Q2
LRATC(bluecurve)
Part (a)
Isn’t the LRATC curve smooth??
• Yes!!
• Have infinitely many SRATC curves so it would be smooth if use all curves
• Each SRATC curve touches the LRATC curve only once
Shape of LRATC
• U-shaped
• Decreasing, Flat, then Increasing
• Important when finding optimal long run output level
Long-Run Average Total Cost Curve (LRATC) Long-Run Average Total Cost Curve (LRATC)
a
Average Cos t (dollars )
Quantity of Output
Dis economiesof Scale
Cons tantReturnsto Scale
SRATC1
SRATC2
SRATC3 SRATC4
SRATC5
SRATC6
SRATC7
Economiesof Scale
A B
LRATC
Minimumeffic ient s cale
Part (b)
0
Economies of Scale
• Downward part of LRATC
• Average costs decrease as output increases
• If have a 1% increase in input usage what happens to output??– Increases by MORE than 1%
• Specialization
Constant Returns to Scale
• Flat portion of LRATC
• Costs remain the same as increase output
• If have a 1% increase in input usage what happens to output??– Output increases by EXACTLY 1%
• First point of constant returns to scale is called MINIMUM EFFICIENT SCALE
Diseconomies of Scale
• Upward sloped portion of LRATC• Costs are rising as we increase output• If have a 1% increase in input usage what happens
to output?– Increases by LESS THAN 1%
• Why???– Firm too large (bad communication or coordination
problems)
Long-Run Average Total Cost Curve (LRATC) Long-Run Average Total Cost Curve (LRATC)
a
Average Cos t (dollars )
Quantity of Output
Dis economiesof Scale
Cons tantReturnsto Scale
SRATC1
SRATC2
SRATC3 SRATC4
SRATC5
SRATC6
SRATC7
Economiesof Scale
A B
LRATC
Minimumeffic ient s cale
Part (b)
0
Are economies, diseconomies, and constant returns to scale in SR, LR, or both???
• LONG RUN ONLY!!!
• Why?– Inputs necessary for production are able to be changed– No fixed inputs
Is this the same as diminishing returns?
• NO
• Diminishing returns is from using ONE plant size intensely– Short run
• Economies of scale is from CHANGING plant size– Long run
Review
• Economies of Scale– LRATC falling
• Constant Returns to Scale– LRATC flat
• Diseconomies of Scale– LRATC rising
Why does economies of scale exist?
• Large firms offer more opportunity for workers to specialize
• Growing firms can take advantage of efficient mass production techniques– Smooth cost over more units produced
Why does diseconomies of scale exist?
• Communication problems
• Shirking
• Management problems
Why is minimum efficient scale important?
• Lowest output level at which ATC are minimized
• Which has a cost advantage??– Small firm at minimum efficient scale point– Larger firm producing more output but still within
constant returns to scale area– Neither
Long-Run Average Total Cost Curve (LRATC) Long-Run Average Total Cost Curve (LRATC)
a
Average Cos t (dollars )
Quantity of Output
Dis economiesof Scale
Cons tantReturnsto Scale
SRATC1
SRATC2
SRATC3 SRATC4
SRATC5
SRATC6
SRATC7
Economiesof Scale
A B
LRATC
Minimumeffic ient s cale
Part (b)
0
Minimum Efficient Scale for Six Industries Minimum Efficient Scale for Six Industries
a
14.16.63.41.91.40.2
%RefrigeratorsCigarettesBeer brewingPetroleum refiningPaintsShoes
INDUSTRY
MES AS APERCENTAGEOF U.S.CONSUMPTION
SOURCE: F. M. Scherer, AlanBechens te in, Erich Kaufer, and R. D.Murphy, The Economics of MultiplantOperation (Cambridge , Mas s .: HarvardUnivers ity Pres s , 1975), p. 80.
Where would you expect to find less firms? (using MES)
• Firms with higher MES• Why??
– Produce until MES
– If MES is higher then each firm will be producing more…so need less firms to cover quantity wanted by economy
• Many SHOE companies (MES = .2)• Few REFRIGERATOR companies (MES = 14)
Efficient Number of Firms• 100 divided by MES• 100% of goods are wanted by consumers• MES is the percentage of consumption each firm will
provide• Cigarette firm’s MES = 6.6
– Need 15 firms
• Petroleum firm’s MES = 1.9– Need 52 firms
• Thus a larger MES means less firms needed
What cause SRTC, LRTC, and MC to shift?
• Taxes– Does it affect FC??
• Only if it is a lump sum tax (tax for existing)• If it is a per unit tax then FC doesn’t change
– How does it change curves??
• Input prices– How does it change curves??
• Technology– Either improves production process (use less inputs)
or lower input prices– How does it change curves??
Homework
• Chapter 8– Questions: 3, 5, 10, and 11
• Working with numbers and graphs– Questions 3, 6, and 7
In-class exercise 12
Do we understand Chapter 8??