Post on 23-Mar-2018
FirmDecisions:ShortRunandLongRun• Afirm’sdecisionsaregroupedas:– Short-rundecisions– timehorizonoverwhichatleastoneofthefirm’sinputscannotbevaried– Long-rundecisions– timehorizonlongenoughforafirmtovaryallofitsinputs
• UsesaProductionFunctiontodeterminehowmuchoutputitwillproducefromagivencombinationofinputs
Example:Q=100K+25L
Ifthefirmincreasescapital(K)itwillincreaseproduction(Q)Ifthefirmincreaseslabor(L)itwillincreaseproduction(Q)
Production Function
ShortRun:Atleastoneinputisfixed– Fixedinputs:Land,machinery,laborwithcontracts– Variableinputs:Labor,energy,fuel
LongRun:Allinputsarevariable– thefirmcanchangetheamountofeachinputthattheyuse
Production Function
Total Product• Totalproduct:Maximumquantityofoutputthatcanbeproducedfromagivencombinationofinputs
• Thetotalproductcurveshowshowthequantityofoutputdependsonthequantityofvariableinput,foragivenquantityofthefixedinput.
Total Product • AssumeFirmAhasonlyonevariableinput:Labor.• Allotherinputsarefixed.
Labor TotalProduct=Output
0 0
1 50
2 90
3 120
4 140
5 150
7 150
Total Product Curve• Witheachadditionalinput:FirmAproducesmoreoutput
• TotalProductCurveisincreasing
01234567
150
140
130
120
90
50
0
TotalTotalProduct
Diminishing Marginal Returns to LaborOutput isincreasingatadecreasingrateiffirmincreasesonlyoneinputEachworkeraddstoproduction, but lessandless
Labor Output MPL0 01 50 502 90 403 120 304 140 205 150 106 150 0
01234567
150
140
130
120
90
50
0
TotalTotalProduct
Production Choices of Firms• Allfirmshaveonegoalinmind:MAXPROFITS
PROFITS=TOTALREVENUE– TOTALCOST
• Twowaystoreachthisgoal:– Maximizetotalrevenue
TotalRevenue=PriceXQuantity– Minimizetotalcosts
TotalCosts=FixedCosts+VariableCosts
Production Costsfor Firms
• FixedCosts:Coststhatstaythesameregardlessofhowmuchafirmproduces
• Example:Rentpaidforastorelocation
Production Costs for Firms • VariableCosts:Coststhatchangebasedonhowmuchafirmproduces– Themorethefirmproduces,themorematerials,workers,inputsithastoemploy– Thecostofthoseinputsarevariablecosts
• Example:WagespaidtoemployeesCostofmaterials
Production Costs for Firms
• TotalCosts:Sumoffixedandvariablecosts– Totalcostsfacedbythefirmtoproduce
• Example:Rent+Wages+CostofInputs
Test your UnderstandingSupposeafirmhastopayarentalpriceof$800foramachineitusesinproduction.Italsopaysitsworkers$25each.Canyoucompletethefollowingtable?
Machines Workers CostofCAPITAL(FixedCost)
CostofLABOR(VariableCost) TOTALCOST
1 5
1 10
1 15
1 20
1 25
1 30
Test your UnderstandingRentPriceofCapital=$800à FIXEDCOSTWagesofworkers=$25à VARIABLECOST
Machines Workers CostofCAPITAL(FixedCost)
CostofLABOR(VariableCost) TOTALCOST
1 5 800 125 925
1 10 800 250 1050
1 15 800 375 1175
1 20 800 500 1300
1 25 800 625 1425
1 30 800 750 1550
How Firms Analyze Production CostsToanalyzetheproductiondecisionsofafirm,recallthatafirmconducts“marginalanalysis”Decisionsarebasedonper-unitcalculations
Therefore, needtocalculatecosts/unit:
AverageVariableCost(AVC)=VariableCost/Quantityproduced
AverageFixedCost(AFC)=FixedCost/Quantityproduced
AverageTotalCost(ATC)=TotalCost/Quantityproduced
Production Costs
OUTPUT
FIXEDCOST
VARIABLECOST
TOTALCOST AFC AVC ATC
100 800 125 925200 800 150 950250 800 175 975
TC/QVC/QFC/Q
Costsperunitofoutputproduced
ProductionCosts
OUTPUT
FIXEDCOST
VARIABLECOST
TOTALCOST AFC AVC ATC
100 800 125 925 8.00 1.25 9.25200 800 150 950 4.00 1.25 5.25250 800 175 975 3.20 1.50 4.70
TC/QVC/QFC/Q
Costsperunitofoutput
produced
Marginal Cost
OUTPUT
FIXEDCOST
VARIABLECOST
TOTALCOST AFC AVC ATC MC
100 800 125 925 8.00 1.25 9.25200 800 150 950 4.00 1.25 5.25250 800 175 975 3.20 1.50 4.70
MarginalCost:ChangeinTotalCostwhenproducingonemoreunitofthegood
MC=(TC2- TC1)/(Q2-Q1)
Marginal Cost
OUTPUT
FIXEDCOST
VARIABLECOST
TOTALCOST AFC AVC ATC MC
100 800 125 925 8.00 1.25 9.25200 800 150 950 4.00 1.25 5.25 1.25250 800 175 975 3.20 1.50 4.70 2.5
MarginalCost:ChangeinTotalCostwhenproducingonemoreunitofthegood
MC=(TC2- TC1)/(Q2-Q1)
Long Run vs. Short Run Total Cost• Intheshortrun:firmhasbothfixedandvariablecosts– Managersmustconsiderthefirmshoulddooverthecourseofthenextweek
• Inthelongrun:allcostsarevariablebecauseallinputsarevariableandcanchange– Managershavealong-termviewwhenconsideringwhatthefirmshoulddointhecomingyears
Costs in the Long Run
AverageTotalCost(Costpercoffeesold)
100Customers
200Customers
300Customers
400Customers
1Location 0.50 0.45 0.55 0.75
2Locations 0.65 0.40 0.60 0.70
3Locations 0.75 0.65 0.50 0.45
Considerasmallcoffeeshop,wherethemajorityofcustomerscomeintobuytheirdailycupofcoffee.Currently,theshopservesabout200customersandhasonlyonelocation.It’sconsideringwhetherornottoexpand.
LongRunvs.ShortRunTotalCost
SRATC1 SRATC2 SRATC3 LRATC1
Output
ATC
EconomiesofScale:ATCisfallingwithincreaseinoutput
LongRunvs.ShortRunTotalCost
SRATC1 SRATC2 SRATC3 LRATC1
Output
ATC
ConstantReturnstoScale:ATCisthesame
LongRunvs.ShortRunTotalCost
SRATC1 SRATC2 SRATC3 LRATC1
Output
ATC
DiseconomiesofScale:ATCisrisingwithincreaseinoutput
Economies of Scale1. IncreasingReturnstoScale(Economiesofscale):
Occursdueto:• Gainsfromspecialization• Minimumsizerequirementsforcertaintypesofequipment.
2. ConstantReturnstoScale:OutputrangewithconstantLRATC
• Sizemaynotmatterandfirmsofthesamesizewillbeequallycost-effective.
3. DecreasingReturnstoScale(Diseconomiesofscale):Firmsreachapointwherebignessbeginstocauseproblems• Onereallylargecoffeeshopserving400+customers• Diseconomiesofscalearemorelikelyathigheroutputlevels