Costs Curves Diminishing Returns Accounting Costs Economic Costs Supply.
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Transcript of Costs Curves Diminishing Returns Accounting Costs Economic Costs Supply.
CostsCurvesDiminishing Returns •Accounting Costs•Economic Costs•Supply
ACCOUNTING COSTS
• Accounting costs are monetary (usually explicit).
• Accounting profit = Revenue – Accounting costs.
ECONOMIC COSTS
• Economic costs = accounting costs + opportunity costs. • Economic profit = revenue – economic costs.• Economic profit = revenue – (accounting costs + opportunity costs).
ECONOMIC COSTS• Economic costs = accounting costs + opportunity
costs.• • In economic analysis we use economic costs.
• To make a wise decision we need to consider all costs and not only monetary costs.
• Opportunity costs should be considered as they have an important bearing on our decision making. These include opportunity cost for resources owned by the firm itself.
OPPORTUNITY COSTS
• Bill owns a farm worth $1m. His yearly revenue is $100,000 and his expenses are $60,000. The current interest rate is 5% for savings. What is Bill’s accounting profit and what is his economic profit?
Accounting profit$$40,000
Economic profit-($10,000)
OPPORTUNITY COSTS• Chen runs her own business. She receives no wage or salary. She
could work full-time for $25,000pa. Her business revenue for last year was $30,000 and her expenses $10,000. What is her accounting profit and her economic profit?
Accounting profit$20000
Economic profit-($5000)
OPPORTUNITY COSTS
• Tao must travel from Wellington to Auckland for business. Tao is paid $20 per hour and he must travel in work time. Prices and times are:
Mode Price $
Hours
Plane $150 1
Car $100 6
Bus $70 10
Which is cheapest?
Plane is cheapest. If we consider opportunity costs, total cost for plane travel is $170 – much cheaper than the other options.
Economic costs in more detail• Rent- Economic return to land (return to any factor
that is in fixed supply)
• Wages- Economic return to labour. It includes all ways people a compensated for providing their time, efforts and skills. (except for enterprise)
• Interest- Economic return on capital.
• Profit- Economic return to enterprise for taking risk. It is the reward to those who run the risk of failure when they bring together all the other factors of production
Do this Now• Last year Mona had a job as a manager for a fishing company,
which paid her $65,000 a year,• She had $80,000 in savings, which gave her a rate of return of
10%. • She thought she could do better by going fishing herself, so
gave up her job and invested $80,000 of her own money in buying a fishing boat and quota.
• By the end of the first year she had sold $140,000 worth of fish and her costs of running the business had been $70,000. She expected the costs to be quite high in the first year, because she was getting the business established, but though these would fall in future years.
• 1. Calculate her accounting profit• 2. Calculate her economic profit• 3. Which are always greater? Economic or accounting profits? Explain
Answers!• 1. Calculate her accounting profit
Revenue - Accounting costs140,000 – 70,000 = 70,000
• 2. Calculate her economic profit Revenue – Economic Costs (accounting costs +
opportunity costs)140,000 – 70,000 – 65,000- (80,000 x0.10) = -
3000
• 3. Which are always greater? Economic or accounting profits? Explain
• Accounting profits are equal to Revenue minus accounting costs. Economic profits are equal to revenue minus accounting costs and opportunity costs. Thus Accounting profits will always be greater than Economic profits due to economic profits taking into account an extra cost, opportunity costs.
Fixed costs are costs that do not vary with output Q FC VC TC
0 100
1 100
2 100
3 100
Fixed costs are costs that do not vary with output Q FC VC TC
0 100 0
1 100 30
2 100 50
3 100 80
Variable costs are costs that increase as output increases
Fixed costs are costs that do not vary with output Q FC VC TC
0 100 0 100
1 100 30 130
2 100 50 150
3 100 80 180
Variable costs are costs that increase as output increases
Total costs = Fixed + Variable costs
FC, VC & TC
Costs($)
Quantity
FC
Fixed costs are costs that do not vary with output
VCVariable costs are costs that increase as output increases
TC
Total costs = Fixed + Variable costs
Average and Marginal CostOutput (Q)
Total Cost
Average Cost
Marginal Cost
0 100 - -
1 200 200 100
2 320 160 120
3 420 140 100
4 640 160 220
5 1100 220 460
AC = TC/Q
Average and Marginal Cost
Output (Q)
Total Cost
Average Cost
Marginal Cost
0 100 - -
1 200 200 100
2 320 160 120
3 420 140 100
4 640 160 220
5 1100 220 460
AC = TC/Q
MC = TC2 - TC1
Starter Activity Number of people in the group (Workers)
Total Product Marginal Product
1
2
3
4
We will assume all groups are equally skilled, so the marginal product is the difference between group one’s total and group two’s total product.
Graph the number of workers on the horizontal axis against the number of blocks sorted on the vertical axis. What do you notice?
fig
Short-run costsShort-run costs
In economics we distinguish between various time periods - ie short and long run.
The short run, which our particular concern, is a period when at least one input to the production process is fixed.
This means that in the short run all production will be subject to the law of diminishing return.
Diminishing Returns
The law of diminishing returns states that where additional units of a variable input are added to a fixed amount of another input, the additional output, or marginal product, will eventually fall.
Diminishing Returns
Fixed Input
Variable input
The additional output(MP) eventually falls
Fixed Input Variable Input
Capital Labour AC MC
Cement Mixer Bricklayers TP (Q) MP Returns (per brick) (per brick)
1 0 0
1 1 70 70 Increasing 6 6
1 2 210 140 Increasing 4 3
1 3 420 210 Increasing 3 2
1 4 630 210 Constant 2.67 2
1 5 770 140 Diminishing 2.73 3
1 6 840 70 Diminishing 3 6
The Shape of the MC curve
Costs($)
Quantity
MC
MC decreases initially because of increasing returns
MC increases because of diminishing returns
Note: always plot the MC curve at the mid-point!
The Shape of Average Cost Curves
Costs($)
Quantity
FC
FC are constant so AFC will continually decline as FC are spread over increasing output
AFC
The Shape of Average Cost Curves
Costs($)
Quantity
AFC
ACAC decreases because of short run economies:•Technical
•Marketing
•Managerial
•Financial
Costs($)
Quantity
AFC
ACAC increases as short run diseconomies set in.
The Shape of Average Cost Curves
Costs($)
Quantity
AFC
ACThe difference between AC and AVC is equal to AFC
AVC
The Shape of Average Cost Curves
Marginal Cost & Average Cost
Costs($)
Quantity
AC
MC
If MC<AC then AC will be decreasing
Costs($)
Quantity
AC
MC
If MC>AC then AC will be increasing
Marginal Cost & Average Cost
Costs($)
Quantity
AC
MC
MC cuts AC at its minimum point - this is the technical optimum
Marginal Cost & Average Cost
Marginal Cost & Average Variable Cost
Costs($)
Quantity
AC
MC
MC also cuts AVC at its minimum point
AVC
Break Even & Shut Down
Costs($)
Quantity
AC
MC
A firm must cover AC if it is to break even
AVC
This is the break even point
Break even point is where AR=AC.
Where the price is enough to cover all costs and the firms make normal profits.
Break Even & Shut Down
Costs($)
Quantity
AC
MC
In the SR a firm can survive if P > AVC
AVC
This is the shut down point
The Supply Curve
Costs($)
Quantity
AC
MC
A firm’s Supply curve is derived from the MC curve above the shut-down point
AVC
=SWhy do you think the supply curve is upwards sloping?
Because of diminishing returns!
Producing higher levels of output results in progressively less efficient resource combinations. Because of this the firm will only supply a larger quantity at higher prices.