McConnellMicro13_Ch07.ppt

PART 3 MICROECONOMICS OF PRODUCT MARKETS Prepared by Dr. Amy Peng Ryerson University © 2013 McGraw-Hill Ryerson Ltd. Explain why economic costs include both explicit (revealed and expressed) costs and implicit costs. Relate the law of diminishing returns to a firm’s short-run production costs. Identify and classify a firm’s short-run production costs as fixed or variable. Use economies of scale to link a firm’s size and production costs in the long run. © 2013 McGraw-Hill Ryerson Ltd. Chapter 7 * The payment that must be made to obtain and retain the services of a resource Explicit Costs Monetary payments Implicit Costs Value of next best use Self-owned resources Includes normal profit © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO1 * Total sales revenue $120,000 Cost of T-shirts $40,000 Clerk’s salary 18,000 Utilities 5,000 Total (explicit) costs 63,000 Accounting profit 57,000 Accounting profit $57,000 Forgone interest $ 1,000 Forgone rent 5,000 Forgone wages 22,000 Forgone entrepreneurial income 5,000 Total implicit costs 33,000 Economic profit 24,000 Example: retail store business © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO1 * Accounting profit = Revenue – Explicit Costs Economic profit = Accounting Profit – Implicit Costs Economic profit (to summarize) =Total Revenue – Economic Costs =Total Revenue – Explicit Costs – Implicit Costs © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO1 * Explicit costs Accounting costs (explicit costs only) Implicit costs (including a normal profit) Economic profit Accounting profit Economic (Opportunity) Costs Total Revenue © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO1 * Short Run Fixed Plant Long Run Variable Plant © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO1 * Total Product (TP) Marginal Product (MP) Average Product (AP) Marginal Product Change in Total Product Change in Labor Input = Average Product Total Product Units of Labor = © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO2 * Resources are of equal quality Technology fixed Variable resources are added to fixed resources At some point, marginal product will fall Rationale © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO2 * © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO2 * (1) Units of the Variable Resource (Labor) (2) Total Product (TP) (3) Marginal Product (MP) Change in (2)/ Change in (1) (4) Average Product (AP), (2)/(1) 0 0 - 1 10 10 Increasing marginal returns 10.00 2 25 15 12.50 3 45 20 15.00 4 60 15 Diminishing marginal returns 15.00 5 70 10 14.00 6 75 5 12.50 7 75 0 10.71 8 70 -5 Negative marginal returns 8.75 TP MP AP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 1 2 3 4 5 6 7 8 9 0 10 20 30 Total Product, TP 1 2 3 4 5 6 7 8 9 20 10 Marginal Product, MP © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO2 * Fixed Costs (TFC) Costs do not vary with output Variable Costs (TVC) Costs vary with output Total Costs (TC) Sum of TFC and TVC TC = TFC + TVC © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * Total Cost Data Average Cost Data Marginal Cost (1) Total Product (Q) (2) Total Fixed Cost (TFC) (3) Total Variable Cost (TVC) (4) Total Cost (TC) TC=TFC+TVC (5) Average Fixed Cost (AFC) AFC = TFC/Q (6) Average Variable Cost (AVC) AVC=TVC/Q (7) Average Total Cost (ATC) ATC = TC/Q (8) Marginal Cost (MC) MC =?TC/?Q 0 $100 $0 $100 1 100 90 190 $100.00 $90.00 $190.00 $90 2 100 170 270 50.00 85.00 135.00 80 3 100 240 340 33.33 80.00 113.33 70 4 100 300 400 25.00 75.00 100.00 60 5 100 370 470 20.00 74.00 94.00 70 6 100 450 550 16.67 75.00 91.67 80 7 100 540 640 14.29 77.14 91.43 90 8 100 650 750 12.50 81.25 93.75 110 9 100 780 880 11.11 86.67 97.78 130 10 100 930 1030 10.00 93.00 103.00 150 Costs 1 2 3 4 5 6 7 8 9 10 0 Q 100 200 300 400 500 600 700 800 900 1000 $1100 TFC TC TVC Total Cost Variable Cost Fixed Cost 7-* © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * Average Fixed Costs AFC = TFC/Q Average Variable Costs AVC = TVC/Q Average Total Costs ATC = TC/Q Marginal Costs MC = ?TC/?Q © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * Costs 1 2 3 4 5 6 7 8 9 10 0 Q 50 100 150 $200 AFC ATC AVC AVC AFC © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * Costs 1 2 3 4 5 6 7 8 9 10 0 Q 50 100 150 $200 AFC MC ATC AVC AVC AFC © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * Figure 7-6 The Relationship between Productivity Curves and Cost Curves MP AP MC AVC Quantity of Output Quantity of Labor Production Curves Cost Curves © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * When MC < current ATC ATC will fall When MC > current ATC ATC will rise MC intersects ATC and AVC at minimum points © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * Factor Prices Price of fixed input increases... AFC and ATC shift up AVC and MC unchanged Price of variable input increases... AVC, ATC, and MC shift up AFC unchanged © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * Technology Improved technology Lower costs Cost curves shift down Curve shifts depend on whether technology affects FC, VC, or both © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO3 * What will costs look like when the firm can choose the best plant size for any given situation? For every plant capacity size, there is a short-run ATC curve All such plant capacities can be plotted. © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Average Total Costs ATC-1 ATC-2 ATC-3 ATC-4 ATC-5 Output 7-* © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Long-run ATC Average Total Costs Output © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Economies of scale Labour specialization Managerial specialization Efficient capital Other factors Constant returns to scale © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Diseconomies of scale Control and coordination problems Communication problems Worker Alienation Shirking © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Minimum Efficient Scale (MES): Lowest level of output where long- run average costs are minimized Can determine the structure of the industry © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Output Average Total Costs Long-run ATC Economies Of Scale Constant Returns To Scale Diseconomies Of Scale q1 q2 © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Output Average Total Costs Economies Of Scale Diseconomies Of Scale Long-run ATC © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Output Average Total Costs Long-run ATC Economies Of Scale Diseconomies Of Scale © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Rising gasoline prices Successful start-up firms The daily newspaper The version stamping machine Aircraft and concrete plants © 2013 McGraw-Hill Ryerson Ltd. Chapter 7,LO4 * Sunk costs Costs have already been incurred and thus are irrecoverable Rule: Do not engage in any activity where MB