Chapter 23: The Firm - Cost and Output Determination ECON 152 – PRINCIPLES OF MICROECONOMICS...
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Chapter 23: The Firm - Cost and Output Determination ECON 152 – PRINCIPLES OF MICROECONOMICS Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
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Transcript of Chapter 23: The Firm - Cost and Output Determination ECON 152 – PRINCIPLES OF MICROECONOMICS...
Chapter 23: The Firm - Cost and Output Determination
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
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Short RunA time period when at least one input, such as
plant size, cannot be changedPlant Size
The physical size of the factories that a firm owns and operates to produce its output
Short Run versus Long Run
Long RunThe time period in which all factors of
production can be varied
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Short Run versus Long Run
Short run and long run are terms that apply to planning decisions made by managers. The firm always operates in the short run in the sense that decisions can only be made in the present.
But some of these decisions result in a long-term commitment of resources.
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ProductionAny activity that results in the conversion of
resources into products that can be used in consumption or inputs to further production
The RelationshipBetween Output and Inputs (Short Run)
Production FunctionThe relationship between inputs and outputA technological, not an economic, relationshipThe relationship between inputs and
maximum physical output
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Law of Diminishing (Marginal) ReturnsThe 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 output
Diminishing Marginal Returns
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Marginal Physical Product The physical output that is due to the addition of one
more unit of a variable factor of production The change in total product occurring when a variable
input is increased and all other inputs are held constant
Also called marginal product or marginal return
The RelationshipBetween Output and Inputs
Average Physical Product Total product divided by the variable input
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Diminishing Returns, the Production Function, and Marginal Product: A Hypothetical Case
Figure 23-1, Panel (a)
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Diminishing Returns, the Production Function,and Marginal Product: A Hypothetical Case
Graphical relationship between marginal physical product and total output
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A BA – Point of Diminishing Marginal Returns
B – Point of Diminishing Total Returns
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Total Costs The sum of total fixed costs and total variable costs
Fixed Costs Costs that do not vary with output
Variable Costs Costs that vary with the rate of production
Short-Run Costs to the Firm
Total costs (TC) = TFC + TVC
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Average Total Costs (ATC)
Short-Run Costs to the Firm
Average total costs (ATC) = total costs (TC)
output (Q)
Short-Run Costs to the Firm
Average total costs (ATC) = total costs (TC)
output (Q)
Average variable costs (AVC) = total variable costs (TVC)
output (Q)
Average fixed costs (AFC) = total fixed costs (TFC)
output (Q)
Marginal costs (MC) = change in total cost
change in output
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Cost of Production: An Example
Figure 23-2, Panel (a)
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Total Cost of Production: An Example
Figure 23-2, Panel (b)
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Total costs
Total variablecosts
9876543210
10
20
Panel (b)
60
50
40
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Output (recordable DVDs per day)
To
tal c
ost
s (d
olla
rs p
er
da
y)
Total fixedcosts
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Average and Marginal Costs of Production: An Example
Figure 23-2, Panel (c)
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As 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 returns), marginal cost will begin to rise.
Short-Run Costs to the Firm
Inefficient to Efficient to Inefficient
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The Relationship Between Returns and Average and Marginal Costs If the wage rate is constant, then the marginal labor cost
associated with each additional unit of output will decline as long as the marginal physical product of labor increases.
When marginal cost is less than average variable cost, then average variable cost will decline. When marginal cost exceeds average variable cost, then average variable cost will increase.
It is also true that the direction of change in average total cost will be determined by whether marginal cost exceeds the current average.
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The Relationship Between Diminishing Marginal Returns and Cost Curves
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AFC
ATC (SAC)
The Marginal and Average Cost Curves
Adding the average fixed cost curve to the graph..
Then,
ATC = AVC + AFC
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Planning HorizonThe long run, during which all inputs are
variable
Long-Run Cost Curves
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Preferable Plant Size and the Long-Run Average Cost Curve
Figure 23-4, Panels (a) and (b)
Panel (b)
Output per Time PeriodQ 2Q1
C3
C1
C4
C2
Panel (a)
Output per Time Period
SAC2
1SAC
SAC3
LAC
1SAC
2SAC
3SAC
4SAC5SAC
6SAC
SAC7
SAC8
Ave
rag
e C
ost
(d
olla
rs p
er
un
it o
f o
utp
ut)
Ave
rag
e C
ost
(d
olla
rs p
er
un
it o
f o
utp
ut)
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Long-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 Curves
ObservationOnly at the minimum of the long-run average
cost curve is the minimum of the short-run average cost curve tangent to it.
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Economies of ScaleDecreases in long-run average costs resulting
from increases in output These economies of scale do not persist
indefinitely, however. Once long-run average costs rise, the curve begins
to slope upwards.
Why the Long-Run Average Cost Curve is U-Shaped
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Reasons for economies of scaleSpecializationDimensional factor Improved productive equipment
Why the Long-Run Average Cost Curve is U-Shaped
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Why the Long-Run Average Cost Curve is U-Shaped Explaining Diseconomies of Scale
Limits to the efficient functioning of management
Coordination and communication is more of a challenge as firm size increases
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Minimum Efficient Scale (MES)The lowest rate of output per unit time at
which long-run average costs for a particular firm are at a minimum
Minimum Efficient Scale
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Minimum Efficient Scale
Figure 23-6
0
Output per Time Period
LAC
B
1,000
A
10
Long
-Run
Ave
rage
Cos
ts(d
olla
rs p
er u
nit)
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Small MES relative to industry demand: There is room for many efficient firms High degree of competition
Large MES relative to industry demand: Room for only a small number of efficient firms Small degree of competition
Minimum Efficient Scale
Chapter 23: The Firm - Cost and Output Determination
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
