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Chapter 7Production andCost of the Firm
These slides supplement the textbook, but should not replace reading the textbook
![Page 2: Chapter 7Chapter 7 Production and Cost of the Firm These slides supplement the textbook, but should not ... The accounting profit earned when all resources used by the firm earn their](https://reader034.vdocuments.us/reader034/viewer/2022042211/5ec0e1e798d67572c40b172a/html5/thumbnails/2.jpg)
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When studying production and costs
of the firm, what assumption do I make?
Producers always attempt to maximize their profit
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When studying the firm, what is the first
thing for me to know?
You must have a working knowledge of key terms
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What should I do to understand this
chapter?You pretend that you are the owner of a business and you are making decisions to maximize your profit or minimize your losses
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What is revenue?
P X Q = total revenue
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What is profit?
TR - TC = Profit
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What is an explicit cost?
Opportunity cost of a firm’s resources that takes the form of cash payments
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What is an implicit cost?
A firm’s opportunity cost of using its own resources or those provided by its owners without corresponding cash payment
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What are total costs?
Explicit costs + implicit costs
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What isaccounting profit?TR minus explicit costs
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What iseconomic profit?
A firm’s total revenue minus its explicit and implicit costs
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What is afixed resource?
Any production cost that does not increase as output increases
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What are some examples of
fixed resources?rent or mortgage
loan payments
certain salaries
a part of utilities
property taxes
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What is avariable cost?
Any production cost that increases as output increases
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What is total cost?The sum of fixed cost and variable cost
FC + VC
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Total revenue……………………...$90,000
Less explicit costs:
Assistant’s salary ………. -$15,000
Material & equipment…..-$20,000
Equals accounting profit………….$55,000
Less implicit costs:
Wanda’s forgone salary……-$40,000
Foregone interest on savings.-$1,000
Forgone garage rental………-$1,200
Equals economic profit…………...$12,800
Accounts of The Wheeler Dealer
Exhibit 1
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What is normal profit?
The accounting profit earned when all resources used by the firm earn their opportunity cost
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Why is normal profit included as part of TC?
Because just as in the payment of wages, normal profit is a necessary expense of running a business
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What does it mean that a firm is
breaking even?
It is making a normal profit
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What is another way I can define
economic profit?
Any money made above and beyond your normal profit
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What is mymarginal revenue?
The money you make by selling the last unit of output
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What is mymarginal cost?
The change in your total cost resulting from a one-unit change in output
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What is the short run?
A period during which at least one of your firm’s resources are fixed
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What is the long run?A period during which all your resources under your firm’s control are variable
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Variable
Resource
(labor per day)
0
1
2
3
4
5
6
7
8
Total
Product
(Tons per day)
0
2
5
9
12
14
15
15
14
Marginal
Product
(Tons per day)
-
2
3
4
3
2
1
0
-1
The short run relationship between units of labor and tons of furniture moved
Exhibit 2
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What is mymarginal product?
The change in your total product that occurs when the usage of a resource increases by one unit, all other resources constant
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What is increasing marginal returns?
This occurs when your marginal product increases as more units of a resource are employed, all other resources constant
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What is the law of diminishing marginal
returns?As more units of a variable
resource are combined with a given amount of fixed resources, eventually the additional units will yield a smaller marginal product
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To
tal
Pro
du
ct
5
10
15
5
4
3
2
1
0
Marg
ina
l P
rod
uct
5 10
Exh
ibit 3
: Th
e To
tal a
nd
M
arg
ina
l Pro
du
ct of L
ab
or
5 10
Increasing marginal returns
Diminishing but positive marginal returns
Negative marginal returns
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Qtons0
2
5
9
12
14
15
Short-Run Cost Data for the Smoother Mover
FC$200
$200
$200
$200
$200
$200
$200
Qworkers0
1
2
3
4
5
6
VC$0
$100
$200
$300
$400
$500
$600
TC$200
$300
$400
$500
$600
$700
$800
MC-
$50.00
$33.33
$25.00
$33.33
$50.00
$100.00
Exhibit 4
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When marginal cost increases, does
average cost increase?
If MC is > than the average, the average will increase
If MC is < the average, the average will decrease
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Tota
l d
oll
ars
Cost
per
to
n
$200
$500
Fixed cost
Variable cost
Total cost
Fixed cost
5 10 15 Tons per day
25
50
5 10 15
Marginal Cost
Exhibit 5
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What is average fixed cost?
Fixed cost divided by output
FC / Q
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What is average variable cost?Variable cost divided by Q
VC / Q
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What is average total cost?
Sum of average fixed cost and average variable cost
AFC + AVC
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Q0
2
5
9
12
14
15
Short-Run Cost Data for the Hypothetical Firm
VC$0
100
200
300
400
500
600
AFC
$100
40.00
22.22
16.67
14.29
13.33
AVC-
$50.00
40.00
33.33
33.33
35.71
40.00
TC$200
$300
$400
$500
$600
$700
$800
MC-
$50.00
$33.33
$25.00
$33.33
$50.00
$100.00
Exhibit 6
ATC-
$150.00
80.00
55.55
50.00
50.00
53.33
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Marginal Cost
Average Variable Cost
Average Fixed Cost
P
QExhibit 7
Average Total Cost
Average & Marginal Cost Curves
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What is thelong-run
average cost curve?
A curve indicating the lowest average cost of production at each level of output when the firm’s size is allowed to vary
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Q
S M
a S1 L L1b
M1
0 q qa q1 qb
Short-Run Average Cost Curves and the Long-Run Planning Curve
Exhibit 8
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$
Q
ATC1ATC2
ATC3
ATC6ATC4
ATC5
ATC7
Family of Many Short-Run Cost Curves Forming a Firm’s Long-Run Planning Curve
Exhibit 9
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What are economies of scale?
Forces that cause reduction in a firm’s average cost as the scale of operation increases in the long run
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What are diseconomies of scale?
Forces that cause a firm’s average cost to increase as the scale of operation increases in the long run
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Costs in the Long Run and Economies of Scale
Output
AC
Economies
of scale
Diseconomies
of scale
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What is the minimum efficient scale?
The lowest rate of output at which a firm takes full advantage of economies of scale
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A BEconomies
of Scale
Constant Average
Cost
Diseconomies of Scale
Long-run average cost curve
$
Q
Exhibit 10
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END