Chapter 9 Businesses  and  the  Costs  of  

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9-­‐2  

Economic Costs

•  The  payment  that  must  be  made  to  obtain  and  retain  the  services  of  a  resource  

•  Explicit  costs  • Monetary  outlay  

•  Implicit  costs  • Opportunity  cost  of  using  self-­‐owned  resources  •  Value  of  next-­‐best  use  •  Includes  a  normal  profit  

LO1  

9-­‐3  

Accounting Profit and Normal Profit

•  Accoun3ng  profit            =  Total  revenue  –  explicit  costs  •  Economic  profit            =  Accoun2ng  profit  –  implicit  costs  •  Economic  profit  (to  summarize)          =  Revenue  –  economic  cost          =  Revenue  –  explicit  costs  –  implicit  costs  

LO1  

9-­‐4  

Explicit  costs  

Accoun3ng  costs  (explicit  costs  

only)  

Implicit  costs  (including  a  

normal  profit)  

Economic  profit  

Accoun3ng  profit  

Econ

omic    

(opp

ortunity)  

costs  

Total  reven

ue  

LO1  

Economic Profit

9-­‐5  

Short Run and Long Run

•  Short  run  •  Some  variable  inputs  •  Fixed  plant  

•  Long  run  •  All  inputs  are  variable  •  Firms  can  adjust  plant  size  as  well  as  enter  and  exit  industry  

LO2  

9-­‐6  

Short Run Production Relationships

•  Total  product  (TP)  •  Marginal  product  (MP)    

•  Average  product  (AP)    

LO2  

Marginal  product    change  in  total  product    change  in  labor  input  

=  

Average  product   total  product      units  of  labor  

=  

9-­‐7  

Law of Diminishing Returns

•  Law  of  diminishing  returns  •  Resources  are  of  equal  quality  •  Technology  is  fixed  •  Variable  resources  are  added  to  fixed  resources  •  At  some  point,  marginal  product  will  fall  

•  Ra2onale  

LO2  

9-­‐8  

Total,  Marginal,  and  Average  Product:  The  Law  of  Diminishing  Returns  

(1)  Units  of  the  Variable  Resource  (Labor)  

(2)  Total  Product  (TP)  

(3)  Marginal  Product  

(MP)  Change  in  (2)/  Change  in  (1)  

(4)  Average  Product  

(AP),  (2)/(1)  

0   0   -­‐  

1   10   10   Increasing  marginal  returns  

10.00  

2   25   15   12.50  

3   45   20   15.00  

4   60   15  Diminishing  marginal  returns  

15.00  

5   70   10   14.00  

6   75   5   12.50  

7   75   0   10.71  

8   70   -­‐5   Nega2ve  marginal  returns  

8.75  

The Law of Diminishing Returns

9-­‐9  

The Law of Diminishing Returns

TP  

MP  

AP  

Increasing  Marginal  Returns  

Diminishing  Marginal  Returns  

Nega3ve  Marginal  Returns  

1   2   3   4   5   6   7   8   9  0  

10  

20  

30  To

tal  produ

ct,  TP  

1   2   3   4   5   6   7   8   9  

20  

10  

Margina

l  produ

ct,  M

P  

LO2  

9-­‐10  

Short Run Production Costs

•  Fixed  costs  (TFC)  •  Costs  that  do  not  vary  with  output  

•  Variable  costs  (TVC)  •  Costs  that  do  vary  with  output  

•  Total  cost  (TC)  •  Sum  of  TFC  and  TVC  •  TC  =  TFC  +  TVC  

LO3  

9-­‐11  

Costs  

1   2   3   4   5   6   7   8   9   10  0   Q  

100  

200  

300  

400  

500  

600  

700  

800  

900  

1000  

$1100  

TFC  

TC  

TVC  

Total  cost  

Variable  cost  

Fixed  cost  

LO3  

Short-Run Production Costs

9-­‐12  

Per-Unit, or Average, Costs

•  Average  fixed  cost    AFC  =  TFC/Q  •  Average  variable  cost  AVC  =  TVC/Q  •  Average  total  cost    ATC  =  TC/Q  •  Marginal  cost      MC  =  ΔTC/ΔQ  

LO3  

9-­‐13  

Short-Run Production Costs

LO3  

Total,  Average,  and  Marginal  Cost  Schedules  for  an  Individual  Firm  in  the  Short  Run  

Total  Cost  Data   Average  Cost  Data  Marginal  Cost  

(1)  Total  Product    

(Q)  

(2)  Total  Fixed  

Cost    (TFC)  

(3)  Total  Variable  

Cost  (TVC)  

(4)  Total  Cost  (TC)  TC=TFC+TVC  

(5)  Average  Fixed  

Cost  (AFC)  

AFC  =  TFC/Q  

(6)  Average  Variable  Cost    (AVC)  

AVC=TVC/Q  

(7)  Average  Total  

Cost  (ATC)  

ATC  =  TC/Q  

(8)  Marginal  Cost  

(MC)  MC  =ΔTC/ΔQ  

0   $100   $0   $100  

1   100   90   190   $100.00   $90.00   $190.00   $90  

2   100   170   270   50.00   85.00   135.00   80  

3   100   240   340   33.33   80.00   113.33   70  

4   100   300   400   25.00   75.00   100.00   60  

5   100   370   470   20.00   74.00   94.00   70  

6   100   450   550   16.67   75.00   91.67   80  

7   100   540   640   14.29   77.14   91.43   90  

8   100   650   750   12.50   81.25   93.75   110  

9   100   780   880   11.11   86.67   97.78   130  

10   100   930   1030   10.00   93.00   103.00   150  

9-­‐14  

Per-Unit, or Average, Costs

Costs  

1   2   3   4   5   6   7   8   9   10  0   Q  

50  

100  

150  

$200  

AFC  

ATC  AVC  

AVC  

AFC  

LO3  

9-­‐15  

Marginal Cost

Costs  

1   2   3   4   5   6   7   8   9   10  0   Q  

50  

100  

150  

$200  

AFC  

MC  

ATC  AVC  

AVC  

AFC  

LO3  

9-­‐16  

Marginal Cost and Marginal Product

Average  prod

uct  a

nd  

margina

l  produ

ct  

Cost  (d

ollars)  

MP  AP  

MC  AVC  

Quan3ty  of  output  

Quan3ty  of  labor  

Cost  curves  LO3  

9-­‐17  

Long Run Production Costs

•  The  firm  can  change  all  input  amounts,  including  plant  size  

•  All  costs  are  variable  in  the  long  run  •  Long  run  ATC  •  Different  short  run  ATCs  

LO4  

9-­‐18  

Firm Size and Costs Av

erage  total  costs   ATC-­‐1  

ATC-­‐2  

ATC-­‐3   ATC-­‐4  

ATC-­‐5  

Output  

LO4  

9-­‐19  

The Long-Run Cost Curve

Long-­‐run  ATC  

Average  total  costs   ATC-­‐1  

ATC-­‐2  

ATC-­‐3   ATC-­‐4  

ATC-­‐5  

Output  

LO4  

9-­‐20  

Economies of Scale

•  Economies  of  scale  •  Labor  specializa2on  • Managerial  specializa2on  •  Efficient  capital  • Other  factors  

•  Constant  returns  to  scale  

LO4  

9-­‐21  

Diseconomies of Scale

•  Diseconomies  of  scale  •  Control  and  coordina2on  problems  •  Communica2on  problems  • Worker  aliena2on  •  Shirking  

LO4  

9-­‐22  

MES and Industry Structure

•  Minimum  efficient  scale  (MES)  •  Lowest  level  of  output  at  which  long  run  average  costs  are  minimized  •  Can  determine  the  structure  of  the  industry  

•  Natural  monopoly  •  Long  run  costs  are  minimized  when  one  firm  produces  the  product  

LO4  

9-­‐23  

MES and Industry Structure

Output  

Average  total  costs  

Long-­‐run  ATC  

Economies  of  scale  

Constant  returns  to  scale  

Diseconomies  of  scale  

q1   q2  

LO5  

9-­‐24  

MES and Industry Structure

Output  

Average  total  costs  

Economies  of  scale  

Diseconomies  of  scale  

Long-­‐run  ATC  

LO5  

9-­‐25  

MES and Industry Structure

Output  

Average  total  costs  

Long-­‐run  ATC  

Economies  of  scale  

Diseconomies  of  scale  

LO5  

9-­‐26  

Applications and Illustrations

•  Rising  gasoline  prices  •  Successful  start-­‐up  firms  •  Verson  stamping  machine  •  The  daily  newspaper  •  Aircrah  and  concrete  plants  

LO5  

9-­‐27  

3D Printers and Mass Customization

•  First  industrial  revolu2on  began  in  1700s  •  Mass  produc2on  led  to  mass  affordability  •  Second  industrial  revolu2on  began  late  1800s  •  Mass  sales  were  necessary  to  spread  R&D  costs  

•  Third  industrial  revolu2on  is  beginning  Now  •  Affordable  mass  customiza2on  with  zero  transporta2on  costs