macroeconomic mcgrowhill micro ch 7 19e use this one

07 Businesses and the Costs of Production McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Chapter Objectives Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Key Terms End Show 8-2 • Why Do Economic Costs Include Both Explicit Costs and Implicit Costs • How Does the Law of Diminishing Returns Relate to a Firm’s ShortRun Production Costs • Learn the Distinctions Between Fixed and Variable Costs and Among Total, Average, and Marginal Costs • Learn the Link Between a Firm’s Size and Its Average Costs in the Long Run Copyright 2008 The McGraw-Hill Companies Economic Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word • Economic Cost • Opportunity Cost • Explicit Costs • Implicit Costs • Normal Profit as a Cost • Economic or Pure Profit Economic Profit Key Terms End Show = Total Revenue - Economic Cost W 8.1 8-3 Copyright 2008 The McGraw-Hill Companies Economic Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Key Terms End Show 8-4 • Equal to opportunity costs • Explicit + implicit costs • Explicit costs – Monetary payments • Implicit costs – Value of next best use – Self-owned resources – Self-employed resources Copyright 2008 The McGraw-Hill Companies 8-4 Profit Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word • Accounting profit – Total revenue less explicit cost • Normal profit – Equal to implicit cost • Economic or pure profit – Total revenue less economic cost Key Terms End Show 8-5 Copyright 2008 The McGraw-Hill Companies 8-5 Profits Compared Economic Profit Versus Accounting Profits Economics Economic Profit Implicit Costs (Including a Normal Profit) Explicit Costs Accounting Total Revenue Economic (Opportunity) Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Accounting Profit Accounting Costs (Explicit Costs Only) Short Run and Long Run •Short Run: Fixed Plant •Long Run: Variable Plant Key Terms End Show 8-6 Copyright 2008 The McGraw-Hill Companies SHORT RUN AND LONG RUN Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Key Terms End Show 8-7 Accounting: Short and long run is based upon annual chronology Economics: Short run has fixed plant capacity size Long run has variable plant capacity size Copyright 2008 The McGraw-Hill Companies Short and Long Run Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word • The short run – Fixed plant capacity – Variable intensity of plant use – Variable output • The long run – Variable plant capacity – Firms enter and exit Key Terms End Show 8-8 Copyright 2008 The McGraw-Hill Companies 8-8 Short-Run Production Relationships Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word • Total Product (TP) • Marginal Product (MP) • Average Product (AP) Change in Total Product Marginal Product = Change in Labor Input Average Product Key Terms = Total Product Units of Labor End Show W 8.2 8-9 Copyright 2008 The McGraw-Hill Companies Law of Diminishing Returns Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word • Fixed technology • Add variable resource to fixed resource • Marginal product will decline – Beyond some point • Rationale Key Terms End Show 8-10 Copyright 2008 The McGraw-Hill Companies 8-10 Cost Curves AP MP Quantity of Labor MC Cost (Dollars) Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Average Product and Marginal Product Short-Run Production Costs Production Curves Key Terms End Show Quantity of Output 8-20 Copyright 2008 The McGraw-Hill Companies AVC Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Long-Run Production Costs • Firm Size and Costs • Long-Run Cost Curve • Economies of Scale – Labor Specialization – Managerial Specialization – Efficient Capital • Diseconomies of Scale • Constant Returns to Scale Key Terms End Show 8-21 Copyright 2008 The McGraw-Hill Companies Long-Run Production Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word • Choose your plant size • Minimize ATC • Different ATC curves – Short run • Long run ATC – Envelope of short run ATC Key Terms End Show 8-22 Copyright 2008 The McGraw-Hill Companies 8-22 Long-Run Production Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Average Total Costs Long-Run ATC Curve ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Output Any Number of Short-Run Optimum Size Cost Curves Can Be Constructed Key Terms End Show 8-23 Copyright 2008 The McGraw-Hill Companies Long-Run Production Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Average Total Costs Long-Run ATC Curve ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Long-Run ATC Output The Long-Run ATC Curve Just “Envelopes” the Short Run ATCs Key Terms End Show 8-24 Copyright 2008 The McGraw-Hill Companies Long-Run Production Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Average Total Costs Long-Run ATC Curve ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Long-Run ATC Output The Long-Run ATC Curve Just “Envelopes” the Short Run ATCs Key Terms End Show 8-25 Copyright 2008 The McGraw-Hill Companies Long-Run Production Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Average Total Costs Alternative Long-Run ATC Shapes Constant Returns To Scale Economies Of Scale Diseconomies Of Scale Long-Run ATC q1 q2 Output Long-Run ATC Curve Where Economies Of Scale Exist Key Terms End Show 8-26 Copyright 2008 The McGraw-Hill Companies Economies and Diseconomies of Scale • Economies of scale • Labor specialization • Managerial specialization • Efficient capital • Other factors • Constant returns to scale LO4 7-27 Economies and Diseconomies of Scale • Diseconomies of scale • Control and coordination problems • Communication problems • Worker Alienation • Shirking LO4 7-28 MES and Industry Structure • Minimum Efficient Scale (MES): • Lowest level of output where longrun average costs are minimized • Can determine the structure of the industry LO4 7-29 Long-Run Production Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Average Total Costs Alternative Long-Run ATC Shapes Economies Of Scale Diseconomies Of Scale Long-Run ATC Output Long-Run ATC Curve Where Costs Are Lowest Only When Large Numbers Are Participating Key Terms End Show 8-30 Copyright 2008 The McGraw-Hill Companies Long-Run Production Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Average Total Costs Alternative Long-Run ATC Shapes Economies Of Scale Diseconomies Of Scale Long-Run ATC Output Long-Run ATC Curve Where Economies Of Scale Exist, are Exhausted Quickly, And Turn Back Up Substantially Key Terms End Show 8-31 Copyright 2008 The McGraw-Hill Companies Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Key Terms Minimum Efficient Scale and Industry Structure • Minimum Efficient Scale (MES) • Natural Monopoly • Applications and Illustrations O 8.3 – Rising Cost of Insurance and Security – Successful Start-Up Firms – The Verson Stamping Machine – The Daily Newspaper – Aircraft and Concrete Plants End Show 8-32 Copyright 2008 The McGraw-Hill Companies Don’t Cry Over Sunk Costs Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Key Terms End Show 8-33 • Sunk Costs Irrelevant in Decision Making • Once Incurred, They Cannot Be Recovered • Compare Marginal Analysis to Find MC and MB • Previously Incurred Costs Do Not Impact the MB=MC Decision • Sunk Costs Are Irrelevant! Copyright 2008 The McGraw-Hill Companies Key Terms Economic Cost s Profits Compar ed Short-Run Produ ction Relations hips Law of Diminish ing Returns Short-Run Prod uction Costs Long-Run Produ ction Costs Minimum Efficie nt Scale and In dustry Structur e Last Word Key Terms • economic (opportunity ) cost • explicit costs • implicit costs • normal profit • economic profit • short run • long run • total product (TP) • marginal product (MP ) • average product (AP) • law of diminishing returns • fixed costs End Show 8-34 Copyright 2008 The McGraw-Hill Companies • variable costs • total cost • average fixed cost (AFC) • average variable cost (AVC) • average total cost (ATC) • marginal cost (MC) • economies of scale • diseconomies of scale • constant returns to scale • minimum efficient scale (MES) • natural monopoly ... Product (Labor) (TP) 0 ] 10 ] 25 ] 45 ] 60 ] 70 ] 75 ] 75 ] 70 Copyright 2008 The McGraw-Hill Companies (3) Marginal Product (MP), Change in (2)/ Change in (1) 10 15 20 15 10 -5 (3) Average Product... returns to scale LO4 7- 27 Economies and Diseconomies of Scale • Diseconomies of scale • Control and coordination problems • Communication problems • Worker Alienation • Shirking LO4 7- 28 MES and Industry... Last Word • Total Product (TP) • Marginal Product (MP) • Average Product (AP) Change in Total Product Marginal Product = Change in Labor Input Average Product Key Terms = Total Product Units of Labor