The Costs of Production

Transcription

1 The of Production P R I N C I P L E S O F ECONOMICS FOURTH EDITION N. GREGORY MANKIW PowerPoint Slides by Ron Cronovich 6 Thomson South-Western, all rights reserved A C T I V E L E A R N I N G : Brainstorming You run General Motors. List different costs you have. List different business decisions that are affected by your costs. In this chapter, look for the answers to these questions: What is a production function? What is marginal product? How are they related? What are the various costs, and how are they related to each other and to output? How are costs different in the short run vs. the long run? What are economies of scale? CHAPTER THE COSTS OF PRODUCTION

2 Total Revenue, Total Cost, Profit We assume that the firm s goal is Profit = Total revenue Total cost the amount a firm receives from the sale of its output the market value of the inputs a firm uses in production CHAPTER THE COSTS OF PRODUCTION : Explicit vs. Implicit Explicit costs require an outlay of money e.g. paying wages to workers Implicit costs Remember one of the Ten Principles: the cost of something is what you give up to get it. This is true whether the costs are implicit or explicit. Both matter for firms decisions. CHAPTER THE COSTS OF PRODUCTION Explicit vs. Implicit : An Example You need $, to start your business. The interest rate is %. Case : borrow $, explicit cost = Case : use $, of your savings, borrow the other $6, explicit cost = $ (%) interest on the loan implicit cost = In both cases, CHAPTER THE COSTS OF PRODUCTION

3 Economic Profit vs. Accounting Profit Accounting profit =total revenue minus Economic profit =total revenue minus Accounting profit CHAPTER THE COSTS OF PRODUCTION 6 A C T I V E L E A R N I N G : Exercise The equilibrium rent on office space has just increased by $/month. Compare the effects on accounting profit and economic profit if a. you rent your office space b. you own your office space 7 The production function A production function shows can be represented by a table, equation, or graph. Example : Farmer Jack grows wheat. He has acres of land. He can hire as many workers as he wants. CHAPTER THE COSTS OF PRODUCTION 9

4 Example : Farmer Jack s production function L (no. of (bushels workers) of wheat) 8 uantity of output,,,,, 8 No. of workers CHAPTER THE COSTS OF PRODUCTION Marginal product The marginal product of any input is E.g., if Farmer Jack hires one more worker, his output rises by the marginal product of labor. Notation: (delta) = Examples: = change in output, Marginal product of labor (MPL) = CHAPTER THE COSTS OF PRODUCTION Example : Total & Marginal Product L (no. of (bushels workers) of wheat) MPL L = = 8 8 CHAPTER THE COSTS OF PRODUCTION

5 Example : MPL = L (no. of (bushels workers) of wheat) 8 8 MPL 8 6 uantity of output MPL equals the slope of the production function.,,, Notice that MPL diminishes as L increases.,, This explains why the production function gets flatter as L increases. No. of workers CHAPTER THE COSTS OF PRODUCTION why MPL is important Recall one of the Ten Principles: Rational people think at the margin. When Farmer Jack Comparing them helps Jack decide whether he would benefit from hiring the worker. CHAPTER THE COSTS OF PRODUCTION why MPL diminishes Diminishing marginal product: E.g., Farmer Jack s output rises by a smaller and smaller amount for each additional worker. Why? In general, MPL diminishes as L rises whether the fixed input is land or capital (equipment, machines, etc). CHAPTER THE COSTS OF PRODUCTION

6 Example : Farmer Jack s costs Farmer Jack must pay $ per month for the land, regardless of how much wheat he grows. The market wage for a farm worker is $ per month. So Farmer Jack s costs are related to how much wheat he produces. CHAPTER THE COSTS OF PRODUCTION 6 Example : Farmer Jack s costs L (no. of (bushels workers) of wheat) cost of land cost of labor Total Cost $, $ $, $, $, $, 8 $, $, $, $, $6, $7, 8 $, $8, $9, $, $, $, CHAPTER THE COSTS OF PRODUCTION 7 Example : Farmer Jack s Total Cost curve (bushels of wheat) 8 8 Total Cost $, $, $, $7, $9, $, Total cost $, $, $8, $6, $, $, $ uantity of wheat CHAPTER THE COSTS OF PRODUCTION 8 6

7 Marginal Cost (MC) Marginal Cost CHAPTER THE COSTS OF PRODUCTION 9 Example : Total and Marginal Cost (bushels of wheat) Total Cost Marginal Cost (MC) $, = TC = $ $, $. 8 8 $, $7, $9, $, CHAPTER THE COSTS OF PRODUCTION Example : The Marginal Cost Curve (bushels of wheat) 8 8 TC $, $, $, $7, $9, $, MC $. $. $. $. $. Marginal Cost ($) $ $ $8 $6 $ $ $ MC usually rises as rises, as in this example.,,, CHAPTER THE COSTS OF PRODUCTION 7

8 Why MC is important Farmer Jack is rational and wants to maximize his profit. To increase profit, should he produce more wheat, or less? To find the answer, Farmer Jack needs to think at the margin. (In the next chapter, we will learn more about how firms choose to maximize their profits.) CHAPTER THE COSTS OF PRODUCTION Fixed costs (FC) Fixed and variable costs For Farmer Jack, FC = Other examples: Variable costs (VC) For Farmer Jack, VC = Other example: Total cost (TC) = CHAPTER THE COSTS OF PRODUCTION Example Our second example is more general, applies to any type of firm, producing any good with any types of inputs. CHAPTER THE COSTS OF PRODUCTION 8

9 Example : FC VC TC $ $ $ $8 $7 $6 $ $ $ $ $ $ FC VC TC 6 7 CHAPTER THE COSTS OF PRODUCTION Example : Marginal Cost TC MC $ $ Recall, $ Marginal Cost (MC) is $7 the change in total cost from producing $ one more unit: $ TC MC = $ Usually, $7 MC rises as rises, due to diminishing marginal product. $ Sometimes (as here), MC falls $ before rising. $ (In other examples, MC may 6be 7 constant.) CHAPTER THE COSTS OF PRODUCTION 6 Example : Average Fixed Cost 6 7 FC $ AFC $ Average $ fixed cost (AFC) is $7 fixed cost divided by the quantity $ of output: $ AFC = FC/ $ Notice $7 that AFC falls as rises: The firm is spreading its fixed $ costs over a larger and larger $ number of units. $ 6 7 CHAPTER THE COSTS OF PRODUCTION 7 9

10 Example : Average Variable Cost 6 7 VC $ AVC $ Average $ variable cost (AVC) is $7 variable cost divided by the quantity of output: $ $ AVC = VC/ $ As $7 rises, AVC may fall initially. In most cases, AVC will $ eventually rise as output rises. $ $ 6 7 CHAPTER THE COSTS OF PRODUCTION 8 Example : Average Total Cost TC $ ATC AFC AVC Average total cost (ATC) 7 $7 $ $ Also, ATC = CHAPTER THE COSTS OF PRODUCTION 9 Example : Average Total Cost TC ATC $ 7 $ $ Usually, $7 as in this example, the ATC curve is U-shaped. $ $ $ $7 $ $ $ 6 7 CHAPTER THE COSTS OF PRODUCTION

11 Example : The various cost curves together ATC AVC AFC MC $ $7 $ $ $ $7 $ $ $ 6 7 CHAPTER THE COSTS OF PRODUCTION A C T I V E L E A R N I N G : Exercise 6 VC Fill in the blank spaces of this table. TC $ 8 6 AFC AVC $ ATC $ MC $ 6 Example : Why ATC is usually U-shaped As rises: Initially, Eventually, $ $7 $ $ $ $7 $ $ $ 6 7 CHAPTER THE COSTS OF PRODUCTION

12 When MC < ATC, When MC > ATC, The MC curve crosses the ATC curve at Example : ATC and MC $ $7 $ $ $ $7 $ $ $ ATC MC 6 7 CHAPTER THE COSTS OF PRODUCTION in the Short Run & Long Run Short run: Long run: In the long run, (e.g. the factory size with the lowest ATC). CHAPTER THE COSTS OF PRODUCTION 6 Example : LRATC with factory sizes Firm can choose from factory sizes: S, M, L. Each size has its own SRATC curve. Avg Total Cost CHAPTER THE COSTS OF PRODUCTION 7

13 Example : LRATC with factory sizes To produce less than A, firm will choose To produce between A and B, firm will choose Avg Total Cost ATC S ATC M ATC L To produce more than B, firm will choose A B CHAPTER THE COSTS OF PRODUCTION 8 A typical LRATC curve In the real world, factories come in many sizes, each with its own SRATC curve. ATC So a typical LRATC curve looks like this: CHAPTER THE COSTS OF PRODUCTION 9 How ATC changes as the scale of production changes Economies of scale: ATC Constant returns to scale: LRATC Diseconomies of scale: CHAPTER THE COSTS OF PRODUCTION

14 How ATC changes as the scale of production changes Economies of scale occur when Diseconomies of scale are due to CHAPTER THE COSTS OF PRODUCTION Conclusion are critically important to many business decisions, including production, pricing, and hiring. This chapter has introduced the various cost concepts. The following chapters will show how firms use these concepts to maximize profits in various market structures. CHAPTER THE COSTS OF PRODUCTION