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TRANSCRIPT
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The Production and Cost
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The Role of the Firm
l The firm is an economic institution that transforms factors of production into consumer goods. It … l Organizes factors of production. l Produces goods and services. l Sells produced goods and services.
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The Firm’s Objective
The economic goal of the firm is to maximize profits.
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A Firm’s Profit
Profit is the firm’s total revenue minus its total cost.
Profit = Total revenue - Total cost Total cost includes all of the opportunity costs
of production
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Economic Profit vs. Accounting Profit
Revenue Total opportunity costs
How an Economist Views a Firm
Explicit Costs
Economic profit
Implicit costs
Explicit costs
Accounting profit
How an Accountant Views a Firm
Revenue
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Costs and Profit l Explicit costs: Monetary payments
the firm makes for the use of resources owned by others. (What do we mean?)
l Implicit costs: Opportunity costs of using the firm’s own self-owned, self-employed resources. (What do we mean?)
l Normal profit: The implicit cost of entrepreneurial talent.
l Economic profit: Total revenue minus economic costs.
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Technology and Production Function l Technology: Production process
that defines how a firm can combine or convert inputs into outputs.
l Production function: Is a function that describes the efficient combination of inputs to produce a certain level of output (the maximum amount of any output a producer can get most efficiently, given a certain level of inputs; or the minimum amount of inputs required to produce a level of output).
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Technology and Production Function
l Marginal product is the additional output that will be forthcoming from an additional unit of input, other inputs remaining constant.
l Average product is calculated by dividing total output by the quantity of the input.
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A Production Table
Number of workers Total output Marginal
product Average product
4 6 7 6 5 3 1 0
-2 -5
1 2 3 4 5 6 7 8 9
10
0 4 5 5.7 5.8 5.6 5.2 4.6 4.0 3.3 2.5
— 4
10 17 23 28 31 32 32 30 25
0
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Outpu
t
32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0
1 2 3 4 5 6 7 8 9 10 Number of workers
TP
Outpu
t per
wor
ker
1 2 3 4 5 6 7 8 9 10 Number of workers
7
6
5
4
3
2
1
0
MP (a) Total product (b) Marginal and average product
AP
Graphical Representation of TP, AP, and MP curves
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The Law of Diminishing Marginal Productivity
l Both marginal and average productivities initially increase, but eventually they both decrease.
l This means that initially the production function
exhibits increasing marginal productivity. l Then it exhibits diminishing marginal productivity. l Finally, it exhibits negative marginal productivity.
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The Law of Diminishing Marginal Productivity
Number of workers
Total output
Marginal product
Average product
Increasing marginal returns
Diminishing marginal returns
Diminishing absolute returns
4 6 7 6 5 3 1 0
-2 -5
1 2 3 4 5 6 7 8 9
10
0 4 5 5.7 5.8 5.6 5.2 4.6 4.0 3.3 2.5
— 4
10 17 23 28 31 32 32 30 25
0
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Outpu
t
Diminishing marginal
returns
Diminishing absolute
returns 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0
1 2 3 4 5 6 7 8 9 10
Increasing marginal
returns
Number of workers
TP
Outpu
t per
wor
ker
1 2 3 4 5 6 7 8 9 10 Number of workers
7
6
5
4
3
2
1
0
MP
Diminishing marginal
returns
Diminishing absolute
returns
(a) Total product (b) Marginal and average product
AP
The Law of Diminishing Marginal Productivity
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Fixed Costs, Variable Costs, and Total Costs
l Fixed costs are those that are spent and cannot be changed in the period of time under consideration. l In the long run there are no fixed costs since
all costs are variable. l In the short run, a number of costs will be fixed.
l Workers represent variable costs – those that change as output changes.
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Family of Total Costs
◆ Total Fixed Costs (TFC) ◆ Total Variable Costs (TVC) ◆ Total Costs (TC)
TC = TFC + TVC
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Family of Total Costs
Quantity Total Cost Fixed Cost Variable Cost 0 $ 3.00 $3.00 $ 0.00
1 3.30 3.00 0.30
2 3.80 3.00 0.80
3 4.50 3.00 1.50
4 5.40 3.00 2.40
5 6.50 3.00 3.50
6 7.80 3.00 4.80
7 9.30 3.00 6.30
8 11.00 3.00 8.00
9 12.90 3.00 9.90
10 15.00 3.00 12.00
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Average Costs
l Average fixed cost equals fixed cost divided by quantity produced.
AFC = FC/Q l Average variable cost equals variable cost divided by quantity produced.
AVC = VC/Q l Average total cost can also be thought of as the sum of average fixed cost and average variable cost. ATC = TC/Q ATC = AFC + AVC
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Marginal Cost l Marginal cost is the increase (decrease)
in total cost of increasing (or decreasing) the level of output by one unit.
QTC=
quantity) in (Changecost) total in (Change
=MC
ΔΔ
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The Cost of Producing Earrings 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 16.67 10 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 11.36 23 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
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Total Cost Curves To
tal c
ost
$400 350 300 250 200 150 100 50 0
FC
2 4
M
6 8 10 20 30 Quantity of earrings
VC TC
L
O
TC = VC + FC
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Average and Marginal Cost Curves l The marginal cost curve goes through the
minimum point of the average total cost curve and average variable cost curve.
l Each of these curves is U-shaped. l The average fixed cost curve slopes down
continuously. l It tells us that as output increases, the same
fixed cost can be spread out over a wider range of output.
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The U Shape of the Average and Marginal Cost Curves
l The law of diminishing marginal productivity sets in as more and more of a variable input is added to a fixed input.
l Marginal and average productivities fall and marginal costs rise.
l When average productivity of the variable input falls, average variable cost rises.
l The average total cost curve is the vertical summation of the average fixed cost curve and the average variable cost curve.
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Per Unit Output Cost Curves C
ost
$30 28 26 24 22 20 18 16 14 12 10
8 6 4 2
0 Quantity of earrings
2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 AFC
AVC ATC MC
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Relationship Between Marginal and Average Costs
l To summarize:
If MC > ATC, then ATC is rising. If MC = ATC, then ATC is at its low point. If MC < ATC, then ATC is falling.
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Relationship Between Marginal and Average Costs
l Marginal and average total cost reflect a general relationship that also holds for marginal cost and average variable cost.
If MC > AVC, then AVC is rising. If MC = AVC, then AVC is at its low point. If MC < AVC, then AVC is falling.
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Relationship Between Marginal and Average Costs
Cos
ts p
er u
nit
$90 80 70 60 50 40 30 20 10
0 Quantity
Area B
Area A Area C MC
ATC AVC
1 2 3 4 5 6 7 8 9 Q1
B
AVC
ATC
MC Q0 A
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Costs in the Long Run
◆ For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered. ◆ In the short run some costs are fixed. ◆ In the long run fixed costs become
variable costs.
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Average Total Cost in the Short and Long Runs...
Quantity of Cars per Day
0
Average Total Cost
ATC in short run with
small factory
ATC in short run with
medium factory
ATC in short run with
large factory
ATC in long run
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Economies and Diseconomies of Scale
Diseconomies of scale
Quantity of Cars per Day
0
Average Total Cost
ATC in long run
Economies of scale
Constant Returns to scale