costs and productivity

8/8/2019 Costs and Productivity

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McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserv

PRODUCTIONPRODUCTIONAND COSTAND COST

ANALYSIS IANALYSIS I

Chapter 9Chapter 9




9-2

Today’s lecture will:Today’s lecture will:

• Differentiate economic profit from accountingprofit.

• Distinguish between long-run and short-runproduction.

• Introduce the law of diminishing marginalproductivity.

• Calculate fixed costs, variable costs, marginalcosts, total costs, average fixed costs averagevariable costs, and average total costs.




9-3

Today’s lecture will:Today’s lecture will:

• Distinguish the various kinds of cost curves anddescribe the relationships among them.

•Explain why the marginal and average cost

curves are U-shaped.

• Explain why the marginal cost curve always goesthrough the minimum point of an average costcurve.




9-4

The Supply ProcessThe Supply Process

• In the supply process, people first

offer their factors of production tothe market.

• Firms transform the factors into

goods that consumers want.• Production is the transformation of

factors into goods.




9-5

The Role of the FirmThe Role of the Firm

• The firm is an economic institutionthat transforms factors of production

into consumer goods. It:Organizes factors of production.

Produces and sells goods and services.

•A virtual firm only organizesproduction and subcontracts out allwork.




9-6

Firms Maximize ProfitFirms Maximize Profit

• Profit = total revenue – total cost

• Economists and accountantsmeasure profit differently.

Accountants focus on explicit costs and

revenues.Economists focus on both explicit and

implicit costs and revenue.


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9-7

Firms Maximize ProfitFirms Maximize Profit

• Economic profit =

(explicit and implicit revenue)

– (explicit and implicit costs)

• Total revenue is the amount a firm receives for selling its good or service plus any increase inthe value of its assets.

• Total cost is explicit payments to resourcesplus the opportunity cost of resourcesprovided by the owners of the firm.



9-8

The Production ProcessThe Production Process

• The production process can bedivided into the long run and theshort run.

• The terms long run and short run donot necessarily refer to specific

periods of time.• They refer to the flexibility the firm

has in changing the level of output.



9-9

The Long Run and the ShortThe Long Run and the Short

RunRun

• A long-run decision is a decision in

which the firm can choose among all

possible production techniques. In the long run, all inputs are variable.

• A short-run decision is one in which the

firm is constrained in regard to whatproduction decision it can make.

In the short run, some inputs are fixed.



9-10

Production FunctionsProduction Functions

• Production function – a curve that describes therelationship between the inputs (factors of production) and outputs.

• It tells the maximum amount of output that can bederived from a given number of inputs.

• Marginal product is the additional output that willbe produced by an additional worker, other factorsremaining constant.

• Average product is total output divided by thenumber of workers.



9-11

A Production Function TableA Production Function Table

Number of workers

Totaloutput

Marginalproduct

Averageproduct

Increasing marginalproductivity

Diminishingmarginalproductivity

Diminishingabsoluteproductivity

46

765

310

25

12

34

567

89

10

045

5.75.8

5.65.24.6

4.03.32.5

—4

10

1723

283132

323025

0



9-12

AA

ProductionProduction

FunctionFunction• Both average and

marginal productivitiesinitially increase, but

eventually they bothdecrease.

• The production functionexhibits:

Increasing marginalproductivity

Then diminishingmarginal productivity

Finally negativemarginal productivity

5 6 71 2 3 8 9 10

Numberof workers

Diminishing marginalproductivit

y

Diminishing absoluteproductivi

ty

32302826

242220181614121086

42

Increasing

marginalproductiv

ity

TP

Outpu

t

Numberof

workers1 2 3 4 5 6 7 8 9 10

7

6

54

3

2

1

0

AP MP

4

Output



9-13

The Law of DiminishingThe Law of Diminishing

Marginal ProductivityMarginal Productivity• Law of diminishing marginal productivity – as

more of a variable input is added to anexisting fixed input, after some point the

additional output from the additional input willfall.

• This law is also called the flower pot law.

• If it did not hold true, the world’s entire foodsupply could be grown in a single flower pot.

9 14



9-14

Fixed Costs, Variable Costs,Fixed Costs, Variable Costs,

and Total Costsand Total Costs

• Fixed costs are those that are spent

and cannot be changed in the periodof time under consideration.

In the long run, there are no fixed costs

since all inputs (and therefore their

costs) are variable.

In the short run, a number of inputs and

their costs will be fixed.

9 15



9-15

Fixed Costs, Variable Costs,Fixed Costs, Variable Costs,

and Total Costsand Total Costs

• Workers represent variable costs –

costs that change as outputchanges.

• The sum of the variable and fixed

costs are total costs.

TC = FC + VC

9 16



9-16

Average CostsAverage Costs

• Average fixed costs AFC = FC/Q

• Average variable cost AVC = VC/Q• Average total cost ATC = TC/Q

or

ATC = AFC + AVC

• Marginal cost is the increase in total

cost of increasing output by one unit.

9 17



9-17

Output FC VC TC MC AFC AVC ATC

3 50 38 88 — 16.67 12.66 29.33

4 50 50 100 12 12.50 12.50 25.00

9 50 100 150 — 5.56 11.11 16.6710 50 108 158 8 5.00 10.80 15.80

16 50 150 200 — 3.13 9.38 12.50

17 50 157 207 7 2.94 9.24 12.18

22 50 200 250 — 2.27 9.09 11.3623 50 210 260 10 2.17 9.13 11.30

27 50 255 305 — 1.85 9.44 11.30

28 50 270 320 15 1.79 9.64 11.42

Costs of ProductionCosts of Production

9 18



9-18

Total Cost CurvesTotal Cost Curves

Total

cost

$400

350

300

250

200

150

10050

0

FC

2 4

M

6 8 10 20 30

Quantity of earrings

VCTC

L

O

TC = VC + FC

9 19



9-19

Per Unit Output Cost CurvesPer Unit Output Cost Curves

Cost

$3028262422201816141210

8

642

0

Quantity of earrings

2 4 6 8 10 12 14 16 18 20 22 2426 28 30 32

AFC

AVCATCMC

9 20



9-20

Average and Marginal CostAverage and Marginal Cost

CurvesCurves

• The marginal cost curve goes

through the minimum point of theaverage total cost curve and average

variable cost curve.

• The average fixed cost curve slopesdown continuously because as

output increases, the same fixed

cost is spread out over more output.

9 21



9-21

The U Shape of the AverageThe U Shape of the Average

and Marginal Cost Curvesand Marginal Cost Curves• When output is increased in the short

run, it can only be done by increasing

the variable input.• The law of diminishing productivitycauses marginal and averageproductivities to fall.

• As average and marginal productivitiesfall, average and marginal costs rise.

9 22




9-22

Productivity and CostsProductivity and Costs

Are Mirror ImagesAre Mirror Images

• The shapes of the cost curves are

mirror-image reflections of thecorresponding productivity curves.

• When one is increasing, the other is

decreasing.• When one is at a maximum, the other

is at a minimum.

9-23




9-23

TheTheRelationshipRelationship

BetweenBetweenProductivityProductivity

and Costsand Costs

Costs

perun

it 1412

108642

0 4 8 12162024

AVCMC

Output

Outpu t

perworke

r

765

4321

0 4 8 12162024Output

A

AP of workers

MP of workers

9-24




9-24

Relationship Between MarginalRelationship Between Marginal

and Average Costsand Average Costs

• If MC > ATC, then ATC is rising

• If MC > AVC, then AVC is rising• If MC < ATC, then ATC is falling

• If MC < AVC, then AVC is falling

• MC = AVC and MC = ATC at their minimum points.

9-25




9 25

Relationship Between AverageRelationship Between Average

and Marginal Costsand Marginal Costs

C

o s t s p e r u n

i t60

5040

30

20

10

0Quantity

Area B

Area A Area C

MCATC

AVC

1 2 3 4 5 6 7 8 9

Q1

B

Q0

A

9-26




9 26

SummarySummary

• Accounting profit is explicit revenue lessexplicit cost.

• Economists include implicit revenue and

cost in determining economic profit.

• Implicit revenue includes the increases inthe value of assets owned by the firm.

•Implicit costs include opportunity cost of time and capital provided by owners of thefirm.

9-27




9 27

SummarySummary

• In the long run a firm can choose among

all possible production techniques; in the

short run it is constrained in its choices

because at least one input is fixed.

• The law of diminishing marginal

productivity states that as more of a

variable input is added to a fixed input, theadditional output will eventually be

decreasing.

9-28




9 28

SummarySummary

• Costs are generally divided into fixedcosts, variable costs, and marginal costs.

• TC = FC + VC

• MC = change in TC• AFC = FC/Q

• AVC = VC/Q

• ATC = AFC + AVC

9-29




9 9

SummarySummary

• AVC and MC are mirror images of theaverage and marginal products.

• The law of diminishing marginal

productivity causes marginal andaverage costs to rise.

• MC goes through the minimum points of the AVC and ATC.

If MC > ATC, then ATC is rising.

If MC = ATC, then ATC is constant.

If MC < ATC, then ATC is falling.

9-30




Review Question 9-1 Given the following productionfunction, find marginal product.

NumberTotal Marginalof Workers Output Product

0 0 _____

1 5 _____

2 11_____

3 15

_____ 4 17

Where does diminishing marginal productivity begin?

2

4

6

5

Diminishing marginal productivity begins after the 2nd worker is hired.

9-31



Review Question 9-2 Assuming that fixed costs are $100,complete the following table.

Output Variable Total Marginal Average AverageCosts Costs Costs Variable Total

Costs Costs0 $ 0 _____

_____

1 200 _____ ______ ______

_____ 2 360 _____ ______

______

_____ 3 500 _____ ______

______ _____

4 750 _____ ______

$100$200

$300$200

300

160

2101,150

850

600

460

300

140

230

213188

167 200

230180

250

costs and productivity

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