The Firm: Cost and Output Determination

*Learning ObjectivesDiscuss the difference between the short run and the long run from the perspective of a firmUnderstand why the marginal physical product of labor eventually declines as more units of labor are employedExplain the short-run cost curves a typical firm facesDescribe the long-run cost curves a typical firm facesIdentify situations of economies and diseconomies of scale

*Did You Know That...

Production technologies and the costs producers face are related?

*Short RunA time period when at least one input, such as plant size, cannot be changedPlant SizeThe physical size of the factories that a firm owns and operates to produce its outputShort Run versus Long Run

*Short Run versus Long RunLong RunThe time period in which all factors of production can be varied

*Short Run versus Long RunManagers take account of both the short-run and long-run consequences of their behavior.While making decisions about what to do today, tomorrow, and next weekthey keep an eye on the long-run benefits.

*The Relationship Between Output and Inputs A firm takes numerous inputs, combines them using a technological production process and ends up with output.We classify production inputs in two broad categorieslabor and capital.

*The Relationship Between Output and InputsQ = output/time period K = capital L = laboror

*The Relationship Between Output and InputsProductionAny activity that results in the conversion of resources into products that can be used in consumption

*The Relationship Between Output and InputsProduction FunctionThe relationship between maximum physical output and the quantity of capital and labor used in the production processThe production function is a technological relationship between inputs and output.

*E-Commerce Example: Put Away the Clay and Turn on the Holographic CameraOnce a company has integrated a holographic camera system into its existing computer network, creating holographic designs takes less time.Consequently, product developers using holographic techniques can now create more designs while utilizing fewer labor resources.

*E-Commerce Example: Put Away the Clay and Turn on the Holographic CameraWhy do technological improvements often reduce labor requirements for specific tasks, thereby allowing labor to be utilized for other purposes?

*The Relationship Between Output and InputsAverage Physical ProductTotal product divided by the variable input

*The Relationship Between Output and InputsMarginal Physical ProductThe physical output that is due to the addition of one more unit of a variable factor of productionThe change in total product occurring when a variable input is increased and all other inputs are held constantAlso called marginal product

*The Production Function and Marginal Product: A Hypothetical Case, Panel (a)

*The Production Function and Marginal Product: A Hypothetical Case

*The Production Function and Marginal Product: A Hypothetical Case

*Diminishing Marginal ProductMeasuring marginal productSpecialization and marginal productDiminishing marginal product

*Law of Diminishing Marginal ProductThe observation that after some point, successive equal-sized increases in a variable factor of production, such as labor, added to fixed factors of production, will result in smaller increases in outputDiminishing Marginal Product

*An Example of the Law of Diminishing Marginal ProductProduction of computer printers exampleWe have a fixed amount of factory space, assembly equipment, and quality control diagnostic software.So the addition of more workers eventually yields successively smaller increases in output.

*An Example of the Law of Diminishing Marginal Product After a while, when all the assembly equipment and quality-control diagnostic software are being used, additional workers will have to start assembling and troubleshooting quality problems manually.The marginal physical product of an additional worker, given a specified amount of capital, must eventually be less than that for the previous workers.

*Short-Run Costs to the FirmTotal CostsThe sum of total fixed costs and total variable costsFixed CostsCosts that do not vary with outputVariable CostsCosts that vary with the rate of production

*Average Total Costs (ATC)Short-Run Costs to the Firm

*Average Variable Costs (AVC)Short-Run Costs to the Firm

*Average Fixed Costs (AFC)Short-Run Costs to the Firm

*Marginal Cost The change in total costs due to a one-unit change in production rateShort-Run Costs to the Firm

*Cost of Production: An Example

*Cost of Production: An Example

*Cost of Production: An Example

*Short-Run Costs to the FirmQuestionWhat do you thinkis there a predictable relationship between the production function and AVC, ATC, and MC?

*Short-Run Costs to the FirmAnswerAs long as marginal physical product rises, marginal cost will fall, and when marginal physical product starts to fall (after reaching the point of diminishing marginal product), marginal cost will begin to rise.

*The Relationship Between Average and Marginal Costs When marginal costs are less than average variable costs, the latter must fall.When marginal costs are greater than average variable costs, the latter must rise.

*The Relationship Between Average and Marginal CostsThere is also a relationship between marginal costs and average total costs.Average total cost is equal to total cost divided by the number of units produced.Marginal cost is the change in total cost due to a one-unit change in the production rate.

*The Relationship Between Diminishing Marginal Product and Cost CurvesFirms short-run cost curves are a reflection of the law of diminishing marginal product.Given any constant price of the variable input, marginal costs decline as long as the marginal product of the variable resource is rising.

*At the point at which diminishing marginal product begins, marginal costs begin to rise as the marginal product of the variable input begins to decline.The Relationship Between Diminishing Marginal Product and Cost Curves

*The Relationship Between Diminishing Marginal Product and Cost CurvesIf the wage rate is constant, then the labor cost associated with each additional unit of output will decline as long as the marginal physical product of labor increases.

*The Relationship Between Output and Costs///

*The Relationship Between Output and Costs

*The Relationship Between Output and Costs

*The Relationship Between Output and Costs

*Long-Run Cost CurvesPlanning HorizonThe long run, during which all inputs are variable

*Preferable Plant Size and the Long-Run Average Cost Curve

*Long-Run Cost CurvesLong-Run Average Cost CurveThe locus of points representing the minimum unit cost of producing any given rate of output, given current technology and resource prices

*Long-Run Cost CurvesObservationOnly at minimum long-run average cost curve is short-run average cost curve tangent to long-run average cost curve.QuestionWhy do you think the long-run average cost curve is U-shaped?

*Why the Long-Run Average Cost Curve is U-Shaped Economies of scaleConstant returns to scaleDiseconomies of scale

*Economies of Scale, Constant Returns to Scale, and Diseconomies of Scale Shown with Long-Run Average Cost Curve

*Why the Long-Run Average Cost Curve is U-ShapedEconomies of ScaleDecreases in long-run average costs resulting from increases in outputThese economies of scale do not persist indefinitely, however.Once long-run average costs rise, the curve begins to slope upwards.

*Reasons for economies of scaleSpecializationDivision of tasks or operationsDimensional factorImproved productive equipmentWhy the Long-Run Average Cost Curve is U-Shaped

*Why the Long-Run Average Cost Curve is U-ShapedExplaining diseconomies of scaleLimits to the efficient functioning of managementCoordination and communication is more of a challenge as firm size increases

*Summary Discussion of Learning Objectives The short run versus the long run from a firms perspectiveShort runa period in which at least one input is fixedLong runa period in which all inputs are variable

*Summary Discussion of Learning ObjectivesThe law of diminishing marginal productAs more units of a variable input are employed with a fixed input, marginal physical product eventually begins to decline.A firms short-run cost curvesFixed and average fixed costVariable and average variable costTotal and average total costMarginal cost

*Summary Discussion of Learning ObjectivesA firms long-run cost curvePlanning horizonAll inputs are variable including plant size

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