copyright 2008 the mcgraw-hill companies 20-1 economic costs profits compared short-run production...
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Copyright 2008 The McGraw-Hill Companies20-1
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
20The Costs ofProduction
Copyright 2008 The McGraw-Hill Companies20-2
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Chapter Objectives• Why Do Economic Costs Include
Both Explicit Costs and Implicit Costs
• How Does the Law of Diminishing Returns Relate to a Firm’s Short-Run 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 Companies20-3
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Economic Costs• Economic Cost• Opportunity Cost• Explicit Costs• Implicit Costs• Normal Profit as a Cost• Economic or Pure ProfitEconomic
ProfitTotal
RevenueEconomic
Cost= -W 20.1
Copyright 2008 The McGraw-Hill Companies20-4
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Profits ComparedEconomic Profit Versus Accounting Profits
EconomicProfit
AccountingCosts (Explicit
Costs Only)
AccountingProfit
ExplicitCosts
Implicit Costs(Including a
Normal Profit)
Eco
no
mic
(Op
po
rtu
nit
y)C
ost
s
To
tal
Rev
enu
e
Economics Accounting
Short Run and Long Run•Short Run: Fixed Plant•Long Run: Variable Plant
Copyright 2008 The McGraw-Hill Companies20-5
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Short-Run Production Relationships
• Total Product (TP)• Marginal Product (MP)• Average Product (AP)
Average Product Total Product
Units of Labor=
Marginal ProductChange in Total Product
Change in Labor Input=
W 20.2
Copyright 2008 The McGraw-Hill Companies20-6
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
IncreasingMarginalReturns
Law of Diminishing Returns• Rationale
• Tabular Example(1)
Units of theVariable Resource
(Labor)
(2)Total Product
(TP)
(3)Marginal Product
(MP),Change in (2)/Change in (1)
(3)AverageProduct
(AP),(2)/(1)
012345678
01025456070757570
1015201510
50
-5
-10.0012.5015.0015.0014.0012.5010.71 8.75
]]]]]]]]
DiminishingMarginalReturns
NegativeMarginalReturns
O 20.1
Copyright 2008 The McGraw-Hill Companies20-7
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Law of Diminishing Returns• Graphical Portrayal
0
10
20
30
To
tal P
rod
uct
, TP
1 2 3 4 5 6 7 8 9
20
10
Mar
gin
al P
rod
uct
, MP
1 2 3 4 5 6 7 8 9
TP
MP
AP
IncreasingMarginalReturns
DiminishingMarginalReturns
NegativeMarginalReturns
O 20.2
Copyright 2008 The McGraw-Hill Companies20-8
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Short-Run Production Costs
•Fixed Costs•Variable Costs•Total Cost
TC = TFC + TVC
Copyright 2008 The McGraw-Hill Companies20-9
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Short-Run Production Costs• Per-Unit or Average Costs
–Average Fixed Cost (AFC)–Average Variable Cost
(AVC)–Average Total Cost (ATC)–Marginal Cost (MC)
AFC =TFC
Q AVC =TVC
Q
ATC =TCQ
= AFC + AVC
MC =Change in TCChange in Q G
raph
ical
ly…
Copyright 2008 The McGraw-Hill Companies20-10
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Short-Run Production CostsTotal Cost, Fixed and Variable Costs
Co
sts
1 2 3 4 5 6 7 8 9 100 Q
100
200
300
400
500
600
700
800
900
1000
$1100
TFC
TC
TVC
TotalCost
VariableCost
FixedCost
Copyright 2008 The McGraw-Hill Companies20-11
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Short-Run Production CostsAverage and Marginal Costs
Co
sts
1 2 3 4 5 6 7 8 9 100 Q
50
100
150
$200
AFC
MC
ATCAVC
AVC
AFC
G 20.1
Copyright 2008 The McGraw-Hill Companies20-12
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Short-Run Production Costs• MC and Marginal Product• Marginal Decisions• Relation of MC to AVC and
ATC• Relationship Between
Productivity Curves and Cost Curves
• Shifts in Cost Curves Graphically…
W 20.3
Copyright 2008 The McGraw-Hill Companies20-13
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Ave
rag
e P
rod
uct
an
dM
arg
inal
Pro
du
ctC
ost
(D
olla
rs)
Short-Run Production Costs
MPAP
MCAVC
Quantity of Output
Quantity of Labor
Production Curves
Cost Curves
Copyright 2008 The McGraw-Hill Companies20-14
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
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
Copyright 2008 The McGraw-Hill Companies20-15
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Long-Run Production CostsLong-Run ATC Curve
Ave
rag
e T
ota
l C
ost
sATC-1
ATC-2
ATC-3 ATC-4
ATC-5
Output
Any Number of Short-Run Optimum Size Cost Curves Can Be Constructed
Copyright 2008 The McGraw-Hill Companies20-16
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Long-Run Production CostsLong-Run ATC Curve
Long-RunATC
Ave
rag
e T
ota
l C
ost
sATC-1
ATC-2
ATC-3 ATC-4
ATC-5
Output
The Long-Run ATC Curve Just“Envelopes” the Short Run ATCs
Copyright 2008 The McGraw-Hill Companies20-17
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Long-Run Production CostsLong-Run ATC Curve
Long-RunATC
Ave
rag
e T
ota
l C
ost
sATC-1
ATC-2
ATC-3 ATC-4
ATC-5
Output
The Long-Run ATC Curve Just“Envelopes” the Short Run ATCs
Copyright 2008 The McGraw-Hill Companies20-18
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Long-Run Production CostsAlternative Long-Run ATC Shapes
Output
Long-Run ATC Curve Where EconomiesOf Scale Exist
Ave
rag
e T
ota
l C
ost
s
Long-RunATC
EconomiesOf Scale
Constant ReturnsTo Scale
DiseconomiesOf Scale
q1 q2
Copyright 2008 The McGraw-Hill Companies20-19
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Long-Run Production CostsAlternative Long-Run ATC Shapes
Output
Long-Run ATC Curve Where Costs AreLowest Only When Large Numbers AreParticipating
Ave
rag
e T
ota
l C
ost
sEconomies
Of ScaleDiseconomies
Of Scale
Long-RunATC
Copyright 2008 The McGraw-Hill Companies20-20
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Long-Run Production CostsAlternative Long-Run ATC Shapes
Output
Long-Run ATC Curve Where EconomiesOf Scale Exist, are Exhausted Quickly,And Turn Back Up Substantially
Ave
rag
e T
ota
l C
ost
s
Long-RunATC
EconomiesOf Scale
DiseconomiesOf Scale
Copyright 2008 The McGraw-Hill Companies20-21
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Minimum Efficient Scale and Industry Structure
• Minimum Efficient Scale (MES)
• Natural Monopoly• Applications and Illustrations
– Rising Cost of Insurance and Security
– Successful Start-Up Firms– The Verson Stamping Machine– The Daily Newspaper– Aircraft and Concrete Plants
O 20.3
Copyright 2008 The McGraw-Hill Companies20-22
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Don’t Cry Over Sunk Costs
• 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!
Last
Word
Copyright 2008 The McGraw-Hill Companies20-23
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
Key Terms• economic (opportunit
y) 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 ret
urns• fixed costs
• 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
Copyright 2008 The McGraw-Hill Companies20-24
Economic CostsProfits ComparedShort-Run Production RelationshipsLaw of Diminishing ReturnsShort-Run Production CostsLong-Run Production CostsMinimum Efficient Scale and Industry StructureLast Word
Key Terms
End Show
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PureCompetition