After reading chapter 7, you should be able to: Explain why economic costs include both explicit (revealed and expressed) costs and implicit (present but not obvious) costs; relate the law of diminishing returns to a firm’s short-run production costs; describe the distinctions between fixed and variable costs and among total, average, and marginal costs; use economies of scale to link a firm’s size and its average costs in the long run.
07 BusinessesandtheCostsof Production McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved EconomicCosts The payment that must be made to • • LO1 obtain and retain the services of a resource Explicit Costs • Monetary payments Implicit Costs • Value of next best use • Self-owned resources • Includes normal profit 7-2 Accounting Profit and Normal Profit • Accounting profit • • LO1 = Revenue – Explicit Costs Economic profit = Accounting Profit – Implicit Costs Economic profit (to summarize) =Total Revenue – Economic Costs =Total Revenue – Explicit Costs – Implicit Costs 7-3 Economic Profit LO1 Implicit costs (including a normal profit) Explicit costs Total Revenue Economic (Opportunity) Costs Economic profit Accounting profit Accounting costs (explicit costs only) 7-4 Short Run and Long Run • Short Run • Some variable inputs • Fixed plant • Long Run • All inputs are variable • Variable plant • Firms enter and exit LO1 7-5 ShortRun Production Relationships • Total Product (TP) • Marginal Product (MP) Change in Total Product Marginal Product = Change in Labor Input • Average Product (AP) Average Product LO2 = Total Product Units of Labor 7-6 Total Product, TP The Law of Diminishing Returns 30 TP 20 10 Marginal Product, MP LO2 20 Increasing Marginal Returns Negative Marginal Returns Diminishing Marginal Returns 10 AP MP 7-7 ShortRun Production Costs • Fixed Costs (TFC) • Costs not vary with output • Variable Costs (TVC) • Costs vary with output • Total Costs (TC) • Sum of TFC and TVC • TC = TFC + TVC LO3 7-8 ShortRun Production Costs $1100 TC 1000 900 TVC 800 Costs 700 600 Fixed Cost 500 400 Total Cost 300 200 Variable Cost 100 TFC LO3 10 Q 7-9 PerUnit, or Average, Costs • Average Fixed Costs • Average Variable Costs • Average Total Costs • Marginal Costs LO3 AFC = TFC/Q AVC = TVC/Q ATC = TC/Q MC = ΔTC/ΔQ 7-10 PerUnit, or Average, Costs $200 Costs 150 ATC AVC 100 AFC 50 AVC AFC LO3 10 Q 7-11 Marginal Cost $200 MC Costs 150 ATC AVC 100 AFC 50 AVC AFC LO3 10 Q 7-12 MC and Marginal Product Production Curves AP MP Quantity of Labor MC AVC Cost Curves Quantity of Output LO3 7-13 LongRun Production Costs • The firm can change all input • • LO4 amounts, including plant size All costs are variable in the long run Long run ATC • Different short run ATCs 7-14 Average Total Costs The LongRun Cost Curve ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Long-Run ATC Output LO4 7-15 Economies and Diseconomies of Scale • Economies of scale • Labor specialization • Managerial specialization • Efficient capital • Other factors • Constant returns to scale LO4 7-16 Economies and Diseconomies of Scale • Diseconomies of scale • Control and coordination problems • Communication problems • Worker alienation • Shirking LO4 7-17 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 7-18 Average Total Costs MES and Industry Structure Constant Returns To Scale Economies Of Scale Diseconomies Of Scale Long-Run ATC q1 q2 Output LO4 7-19 Don’t Cry Over Sunk Costs • Sunk costs • Costs have already been incurred • • and thus are irrecoverable Rule: Do not engage in any activity where MB