# Costs of Production by liaoqinmei

VIEWS: 3 PAGES: 67

• pg 1
```									CHAPTER 23 -Costs of
Production
How  much output can a firm
produce?
How do the costs of
production vary with the rate
of output
Do larger firms have a cost
firms?
Production Function…i.e.
Costs of Production
Next Step for Production
Function
 How many inputs does it take to arrive at the
desired mix of outputs. (from the factors)
*How many workers will it take to make the
new Board Game… I LOVE ECONOMICS?

of Production Function:
 Definition
Relationship between the maximum quantity
of a good attainable from different
combinations of factor inputs.
Maximum Output/Minimum
Inputs
Production of goods equates cost!
Idea for a firm (large or small) is to
minimize the cost while maximizing
output.
How best to produce?
What’s the smallest amount of resources
needed to produce a specific product?
*What is the least number of workers we
can hire to handle the noon counter
trade? (McDonalds). Can we lay off
another 1,000 workers and still be
competitive (IBM) Ford lays off 15,000
workers
(Factors of production=land,labor,capital,
entrepreneurship
what the maximum amount of output
is attainable from various combinations
of factor inputs. (this is getting the mixing
bowl filled with right ingredients)

With a fixed amount of capital adding
labor inputs can predict outputs---up
to a certain point---then more capital
Law of Diminishing Returns
   *Did you ever fall asleep reading your
economics text after a long day at work?
Or maybe you just procrastinated on
getting that book open.. Of course you
have…..… you have experienced
   Diminishing returns.
 In   the short run—Production
function defines the limit to
output and how much each
worker will contribute to that
limit.
 Thefactor that can be adjusted
quickly in the SR is Labor.

 Yet…  as more labor is hired,
each unit of labor has less
capital and land to work with…
 Things get constrained.. Hence.
Marginal Physical Product
declines
 This refers to how many
widgets
Set up a small factory    If you keep adding
Fixed factor of            workers- will reach a
production(4             point where the
Functions of machines      nothing to our total
one at a time.          A business person
must be aware of the
law of diminishing
returns if he wants to
operate efficiently.

Example/Build a City game
Machines   Workers   Total    Approx     Marginal
Output   Average    Product
Output

4          0         0        0         0
4          1         20       20        20
4          2         45       22.5      25
4          3         80       26.5      35
4          4         130      32.5      50
4          5         160      32        30 ***
4           6        180      30        20
4          7         190      27.1      10
4          8         185      23.1      -5
Bottom Line
If we keep adding workers we will reach
a Point where--- the Marginal Worker
ads nothing to our total output * All
the checkout lanes are filled with Tom
Thumb Employees… very few people
are checking out. (Is this productive
for TT?)
What happens to their Profit Margin?
Cost exceeds any benefits of hiring
Short run= period in which the quantity
(and quality of some inputs) cannot be
changed.
General assumption: In SR labor can
change while capital is held constant
Generally, as amount of labor used
increases, the output will also increase
(with reservations) See diminishing
returns*

Long run/short run productivity
MPP (marginal physical product)=
The change in total output that results from
employment of one additional unit of
input.

Formula: MPP = change in total output
change in input quantity
*same figure as approximate avg output.
On diminishing returns chart…

Marginal Productivity
Employment Dilemmas
Sometimes
employees
don’t
measure
up
*Output
does
not justify
Their
negative
inputs
Marginal Physical Product
MPP-
 Marginal Productivity
 When the MPP of labor (MPPL >0), then
total output increases.
 Improving the ratio of labor to other factors
increases the MPP of labor.
MPP = ∆Q
∆L
MPP Chart
Marginal Physical Product
Fixed Input   Variable      Quantity of   MPP of
Input labor   Output Q      Variable
Input
1             0             0
1             1             18            18
1             2             37            19
1             3             57            20
1             4             76            19
1             5             94            18
MPP Graph(actually
diminishing marginal physical
product.
50       Total output                E                         I
45        (per day)       D
40                              + 10 jeans
35                C
30                    Third worker
25
20                         Marginal physical product
15        B       c
b             d (per worker)
10
e
5
0   A
a     1      2         3        4       5   6     7       8
i
 The MPP actually mirrors the
output/worker.
 MPP is the additional output obtained by
employing one more unit of input..
 If MPP     each additional unit of input is
more cost to each additional input.
 . (i.e. input cost is rising= marginal cost is
increasing

Falling MPP implies Rising MC
Diminishing marginal productivity implies . . .      Rising marginal cost
24                                              1.20
Marginal Physical Product

20         c                                                      1.00                         1/g

16   b                                                            0.80
12              d                                                 0.60
1/f
8                                                                0.40
e                                                             1/e
4                                                                0.20   1/b 1/c 1/d
Falling MPP Implies Rising
f
g h

Cost
Marginal Input5 6 7 8i
0 1 2 3 4
Labor
0 1 2 3 4 5
Labor Input
6     7
   What about Marginal Revenue? The
change in total revenue associated with

 If marginal costs are increasing
marginal revenue is decreasing.
Productivity- Right Mix of
Output
REVIEW TERMINOLOGY
   Factors of production- Resource inputs
used to produce goods and services
(land,labor,capital, entrepreneurship)
 Productivity-Output per unit of input
(output per labor hour)
 Efficiency-maximum output of a good from
the resources used in production
 Opportunity Cost-The MOST DESIRABLE
G&S that are forgone in order to obtain
something else.
 Short Run-The period in which the quantity
(and/or quality) of some inputs cannot be
changed.
1.   If input prices are rising, will Marginal
cost be rising?

2.   If you have a fixed amount of capital
and continue to add labor inputs, will
marginal product always increase?

3.   What is marginal physical product?

Quick quiz
 All competition that is not PURE is
IMPERFECT
 Whether a firm exists in a perfectly
competitive market or imperfectly
competitive market, it will TRY to
 MAXIMIZE PROFITS or MINIMIZE
LOSSES.

Costs, Prices, Output in
Competitive Markets
What is a definition of profit?

Fixed, Variable, Total Costs
Which market might this carton apply today?
   TR-TC=PROFIT

 How much money am I taking in? (TR)
 How much is it costing me to produce my
output? (TC)

Economic Profit vs Accounting
Profit
(the difference lies in how cost is
defined)
Accounting Costs are
all the costs that
Economic Cost =
have an explicit
Explicit Cost +
dollar cost
Implicit Cost
attached to it. TR-
TC
•Economic cost represents the value of all
resources used to produce a good or service;
opportunity cost.
The two diverge whenever a factor of production is
not paid an explicit wage… (rent) (own the land)
(not paying yourself a salary)
Accounting, Economic and
Normal Profit II
Suppose a company incurs the following
costs: labor, \$400; equipment, \$300;
and materials, \$100. The company
owns the building so it doesn’t have
to pay the usual \$800 in rent.
a) What is the total accounting cost?
b) What is the total economic cost?
c) How would accounting and economic
costs change if the company sold the
building and then leased it back?
   All costs are classified as fixed or variable. In
the short run, the firm can only use its
existing facilities to increase its output.
During the short-run, there are several
important costs that are fixed.
   Fixed costs do not change when the firm
changes its level of output
   Name some—
   -interest on debts of the firm, payments
for rent, insurance premiums, taxes on
real property, salaries.

Fixed Costs:
 Average fixed cost, AFC declines as the
firm increases its output.
 Divide TFC by Q = AFC

TFC/Q = AFC

Average Fixed Cost AFC
c
2O   3   4   5   6   7   8   9   10
S
T
S                               AFC
Quantity

Graph
If a firm had nothing but fixed costs, the
more it produced the lower its unit cost
(AFC) However, the firm is also
confronted by variable costs.
What are Variable Costs?
Variable Costs increase as the firm
increases its output.
All costs that are not fixed---are variable!

Graph explanation
Continued Variable Costs
When a firm increases its output, it must
acquire more productive resources.
Examples:
More laborers
Wages
Electricity
Paint, sugar, plastic, steel, etc.
***Variable costs: any costs that rises as
the firm produces more; and costs that
fall as the firm produces less.
****This is the cost that producers have
control over.
1. Mortgage payments on a factory
2. Electric bills at a print shop
3. The cost of a new robot at General
Motors plant
4. Premiums on liability insurance at the
XYZ Corporation
5. Wages paid to auto workers
6. Contract paid to top management at GE

Quick Quiz
Identify which is Fixed or Variable
Cost
The bottom line is
productivity whether
Bottom Line---                it is a worker on an
assembly line or a
CEO.
Remember: Harry
Truman said
recession is when a
neighbor loses his
job..depression is
when you lose
yours! 

Why is productivity measured by the federal government?
AVC is found by dividing TVC by Q
TVC/Q = AVC

Although Average fixed cost declines
continually, average variable cost does
not. At first AVC usually declines as the
firm’s output increases. After reaching a
minimum, then AVC begins to rise.

Total Variable Cost and
Average Variable Cost
AVC and Diminishing Returns

The AVC curve will have the general shape
of the letter U. This is explained by the
Law of diminishing returns.

Law says: as more and more units of a
variable factor of production are added to
a fixed factor of production (such as
capital equipment) eventually a point will
be reached at which the output accounted
for by each additional unit of the variable
factor will start to decline.
Total Cost
Total Cost is the sum of total fixed cost and
total variable cost.
When a firm increases its output, total cost
tends to rise
Fixed cost remains unchanged, naturally,
but total cost will be pulled up by the
rise in total variable cost with the rise
in output.
ATC= TC/Q or adding AFC + AVC
 Marginal Resource Cost
 Marginal cost (MC) is the increase in
total costs associated with a one unit
chart)
Change in total cost
Marginal cost =
Change in output

MC = C
Q

Marginal Cost- controllable cost
How to determine marginal cost
Total      Total FC   Total VC   Total Cost   Marginal
Output                                        Cost

0          \$2000      \$     0    \$2,000       \$ 0
1          \$2000      \$l,500     \$3,500       \$1,500
2          \$2000      \$2,600     \$4,600       \$1,100
3          \$2000      \$3,600     \$5,600       \$1,000
4          \$2000      \$4,800     \$6,800       \$1,200
5          \$2000      \$6,125     \$8,125       \$1,325
6          \$2000      \$7,800     \$9,800       \$1,675
7          \$2000      \$9,800     11,800       \$2,000
8          \$2000      12,000     14,000       \$2,200
\$24
I
20
Costs (dollars per pair)

J                                     ATC
16                                                 O
K
L              M      N
12

8                                              AVC

4                                              AFC

0   10       20           30              40         50
Rate of Output (pairs per day)

Graph ATC/AVC/AFC
 The bottom of the U-shaped average total
cost curve represents the minimum
average total costs.
 It identifies the lowest possible
opportunity costs to produce the
product.******

Minimum Average Cost
   The output decision has to be based not
only on the capacity to produce (the
production function) but also on the costs
of production (the cost functions).

A Cost Summary
 Themarginal cost curve
always intersects the ATC
curve at its lowest point.

MC

ATC

A Cost Summary
Basic Cost Curves
\$32
MC
28
Cost (dollars per unit)

24
20
16
12                                            ATC
AVC
8                    m
4
n                               AFC
0    1    2    3     4     5      6   7      8    9
Rate of Output (units per time period)
Friendly reminders
 If marginal is greater than average, then
average must be rising..(your 3 exams
average to 85.. Your 4th is 92.. Your
average will increase above 85)
 If marginal is less than average, then
74. This will pull down the average of 85)
 If marginal equals average, then average
is at its extreme (neither rising or falling)
at that point..With a grade of 85 on your
change if you had an 85 average on the
other three exams.
   Whenever a number added to a series of
numbers is less than their average, the
average must decline……….
   When a number added to a series of numbers
is larger than their average, the average
must rise…..

   Marginal Cost helps a firm decide
whether to increase or decrease output.
   Marginal cost is the cost that the firm
can control most directly.

Mathematical Rule
If MC > ATC, ATC is increasing
If MC < ATC, ATC is decreasing
If MC = ATC, ATC at minimum

A Cost Summary
\$32
28
Cost (dollars per unit)

24
20
16
12
8
4

0   1   2     3    4     5    6     7    8   9

Rate of Output (units per time
period)
Identify these curves!
 Short   Run - A period of time in which
some inputs in the production process
are fixed.
 Long Run - A period of time in which
all inputs in the production process can
be varied (no inputs are fixed).

Production and Cost:
Short and Long Run
   Over the long-run---ALL COSTS ARE
VARIABLE.
   Taxes, interest rates, and other costs that are
fixed in the SR can change.
   The size of the firm can also affect costs.
The principle that explains this is called:

ECONOMIES OF SCALE- (means as firms
enlarge their plants, their unit costs decline
because of mass production and other factors
such as:
Specialization, factor substitution, better
stability.

LONG RUN Costs
Long- Run Costs Continued
   There are no fixed costs in the long-run
   The long-run cost curve is just a summary
of our best short-run cost possibilities
using existing technology facilities.

   Like all average cost curves, the long-run
LATC curve has its own marginal cost
curve. The long-run marginal cost LMC
curve is not a composite of short-run
marginal cost curves. Rather it is
computed on the basis of the costs
reflected in the long-run ACT curve itself.
Marginal Physical Product and
Marginal Cost I
Notice that as the
MPP curve rises,
the MC curve falls;
and as the MPP
curve falls, the MC
curve rises.
     A cost incurred in the past that cannot
be changed by current decisions and
therefore cannot be recovered.

Sunk Cost
Best for output levels below a
Best for output levels in
Excess of b
Costs (dollars per pair)

ATC1
ATC2
ATC3

Long-run average
total cost (LATC)
Long-Run Average Costs c
0    40 a 60         b
determined jeans per day)
LR Costs are Rate of Output (pairs of by SR options.
   The long-run marginal costs curve
intersects our long-run cost curve at its
lowest point.

Long-Run Marginal Costs
LMC
Costs (dollars per pair)

ATC2

LATC

m2

Long-Run Costs with Unlimited
Options
0      q2
Rate of Output (jeans per day)
   There are many optional plant sizes
available in long-run production.

One  option is the decision
to use one large plant or
several smaller plants to
produce a given amount of
output.
Economies of Scale
Constant Returns= increases in plant size
do not affect minimum average cost…
minimum per-unit costs are identical for
small plants and large plants.
Diseconomies of Scale=increase in plant
size results in reducing operating
efficiency

Constant Returns to Scale and
Diseconomies of Scale
Constant returns to scale       Economies of scale         Diseconomies of scale
COST (dollars per unit)

ATC3
ATC1
ATCS                        ATCS           ATC2          ATCS     m3
m1
m2
c                           c                           c

0               QM          0              QM          0                QM
RATE OF OUTPUT              RATE OF OUTPUT              RATE OF OUTPUT
(units per period)          (units per period)          (units per period)
Economies of Scale
Answer – No and Yes respectively. Low wages
are not a reliable measure of global
competitiveness.
Competition regardless of where it takes place,
has to produce MORE OUTPUT for a given
quantity of INPUTS.
*****A worker’s contribution to the production
process is measured by MPP. A worker’s MPP
depends on the quantity and quality of
other resources in the production process
plus the worker’s educational skills and skill-
level.
Question: Are trade deficits a signal that the
U.S. cannot compete in the global
marketplace?
Is Outsourcing Good?
U.S. Labor vs Mexico Labor
   The higher wages
paid in America as
opposed to Mexico
reflects the capital
used in American
production,
education of the
technology, etc.---
must measure
UNIT LABOR COST
Should the federal government be criticized for NAFTA?
America:              Mexico:
Unit Labor Cost =     Unit Labor Cost =
\$12.00 per hour       \$3.00 per hour
6 units per hour      1 unit/hr
= \$2/unit of output   = \$3/unit of output

Checking unit labor cost
Unit Labor cost = wage rate
MPP
 Low wage rate does not always indicate
lower unit output cost. *Service jobs are
an exception if education stays
level…China has lower wage rate…so
should HP produce printers there?
 Mexican labor in the previous example
would be more costly to use even though
the wage rate is lower.

Real World Labor Cost/wage rate
Japan – supply chain halt
Think of the many
products in the U.S.
that are dependent
on parts and
products from
Japan.
Bottom Line Productive
Statement

   Productivity in any economy means
staying competitive in the global
markets and ―making more things‖
than others.

```
To top