Micro Economics CH 4 about opportunity cost
- 1. Harcourt Brace & Company THE COSTS OF PRODUCTION Chapter 4
- 2. Harcourt Brace & Company The Costs of Production The Law of Supply ä Firms are willing to produce and sell a greater quantity of a good when the price of the good is high. ä This results in a supply curve that slopes upward.
- 3. Harcourt Brace & Company The Firm’s Objective The economic goal of the firm is to maximize profits.
- 4. Harcourt Brace & Company A Firm’s Total Revenue and Total Cost Total Revenue ä The amount that the firm receives for the sale of its product. Total Cost ä The amount that the firm pays to buy inputs.
- 5. Harcourt Brace & Company A Firm’s Profit Profit is often referred to as producer surplus. It is the amount a seller is paid minus costs. Profit = Total revenue - Total cost
- 6. Harcourt Brace & Company Costs as Opportunity Costs A firm’s costs of production include all the opportunity costs of making its output of goods and services.
- 7. Harcourt Brace & Company Explicit and Implicit Costs A firm’s cost of production include explicit costs and implicit costs. ä Explicit costs involve a direct money outlay for factors of production. ä Implicit costs do not involve a direct money outlay.
- 8. Harcourt Brace & Company Economic Profit versus Accounting Profit Economists include all opportunity costs when measuring costs. Accountants measure the explicit costs but often ignore the implicit costs.
- 9. Harcourt Brace & Company Economic Profit versus Accounting Profit When total revenue exceeds both explicit and implicit costs, the firm earns economic profit. ä Economic profit is smaller than accounting profit.
- 10. Harcourt Brace & Company Economic Profit versus Accounting Profit Revenue Total opportunity costs How an Economist Views a Firm Explicit costs Economic profit Implicit costs
- 11. Harcourt Brace & Company Economic Profit versus Accounting Profit Revenue Total opportunity costs How an Economist Views a Firm Explicit costs Economic profit Implicit costs Explicit costs Accounting profit How an Accountant Views a Firm Revenue
- 12. Harcourt Brace & Company Production and Costs A firm’s costs reflect its production process.
- 13. Harcourt Brace & Company The Production Function The production function shows the relationship between quantity of inputs used to make a good and the quantity of output of that good.
- 14. Harcourt Brace & Company Marginal Product The marginal product of any input into production is the increase in the quantity of output obtained from an additional unit of that input.
- 15. Harcourt Brace & Company Marginal Product The marginal product of any input into production is the increase in the quantity of output obtained from an additional unit of that input. M a r g i n a l p r o d u c t = A d d i t i o n a l o u t p u t A d d i t i o n a l i n p u t
- 16. Harcourt Brace & Company Diminishing Marginal Product Diminishing marginal product is the property whereby the marginal product of an input declines as the quantity of the input increases. Example: As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment.
- 17. Harcourt Brace & Company Diminishing Marginal Product The slope of the production function measures the marginal product of an input, such as a worker. When the marginal product declines, the production function becomes flatter.
- 18. A Production Function Quantity of Output (cookies per hour) 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 Number of Workers Hired 0 1 2 3 4 5 Production function
- 19. Harcourt Brace & Company Production Function and Total Costs The relationship between the quantity a firm can produce and its costs determines its pricing decisions. The total-cost curve shows this relationship graphically.
- 20. Harcourt Brace & Company A Production Function and Total Cost Number of Workers Output (Quantity) Marginal Product of Labor Cost of Factory Cost of Workers Total Cost of Inputs 0 0 $30 $0 $30 1 50 50 30 10 40 2 90 40 30 20 50 3 120 30 30 30 60 4 140 20 30 40 70 5 150 10 30 50 80
- 21. Total-Cost Curve Total Cost $80 70 60 50 40 30 20 10 Quantity of Output (cookies per hour) 0 20 40 140 120 100 80 60 Total-cost curve
- 22. Harcourt Brace & Company The Various Measures of Cost Costs of production may be divided into fixed costs and variable costs.
- 23. Harcourt Brace & Company The Various Measures of Cost Fixed costs are those costs that do not vary with the quantity of output produced.
- 24. Harcourt Brace & Company The Various Measures of Cost Variable costs are those costs that do vary with the quantity of output produced.
- 25. Harcourt Brace & Company Family of Total Costs Total Fixed Costs (TFC) Total Variable Costs (TVC) Total Costs (TC) TC = TFC + TVC
- 26. Family of Total Costs Quantity Total Cost Fixed Cost Variable Cost 0 $ 3.00 $3.00 $ 0.00 1 3.30 3.00 0.30 2 3.80 3.00 0.80 3 4.50 3.00 1.50 4 5.40 3.00 2.40 5 6.50 3.00 3.50 6 7.80 3.00 4.80 7 9.30 3.00 6.30 8 11.00 3.00 8.00 9 12.90 3.00 9.90 10 15.00 3.00 12.00
- 27. Harcourt Brace & Company Average Costs Average costs can be determined by dividing the firm’s costs by the quantity of output produced. The average cost is the typical cost of each unit of product.
- 28. Harcourt Brace & Company Family of Average Costs Average Fixed Costs (AFC) Average Variable Costs (AVC) Average Total Costs (ATC)
- 29. Harcourt Brace & Company Family of Average Costs AFC = Fixed cost Quantity = FC Q AVC = Variable cost Quantity = VC Q ATC = Total cost Quantity = TC Q
- 30. Harcourt Brace & Company Table 13-3 Various Measures of Cost: Big Bob’s Bagel Bin Quantity of Bagels/hour Fixed Cost Variable Cost Total Cost AFC AVC ATC Marginal Cost 0 $2.00 $0.00 $2.00 -- -- -- -- 1 2.00 1.00 3.00 $2.00 $1.00 $3.00 $1.00 2 2.00 1.80 3.80 1.00 0.90 1.90 0.80 3 2.00 2.40 4.40 0.67 0.80 1.47 0.60 4 2.00 2.80 4.80 0.50 0.70 1.30 0.40 5 2.00 3.20 5.20 0.40 0.64 1.04 0.40 6 2.00 3.80 5.80 0.33 0.63 0.96 0.60 7 2.00 4.60 6.60 0.29 0.66 0.95 0.80 8 2.00 5.60 7.60 0.25 0.70 0.95 1.00 9 2.00 6.80 8.80 0.22 0.76 0.98 1.20 10 2.00 8.20 10.20 0.20 0.82 1.02 1.40 11 2.00 9.80 11.80 0.18 0.89 1.07 1.60 12 2.00 11.60 13.60 0.17 0.97 1.14 1.80 13 2.00 13.60 15.60 0.15 1.05 1.20 2.00 14 2.00 15.80 17.80 0.14 1.13 1.27 2.20
- 31. Family of Average Costs Quantity AFC AVC ATC 0 — — — 1 $3.00 $0.30 $3.30 2 1.50 0.40 1.90 3 1.00 0.50 1.50 4 0.75 0.60 1.35 5 0.60 0.70 1.30 6 0.50 0.80 1.30 7 0.43 0.90 1.33 8 0.38 1.00 1.38 9 0.33 1.10 1.43 10 0.30 1.20 1.50
- 32. Harcourt Brace & Company Marginal Cost Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production. Marginal cost helps answer the following question: ä How much does it cost to produce an additional unit of output?
- 33. Harcourt Brace & Company Marginal Cost M C= C hangeintota l cost C hangeinquantity = T C Q M C= C hangeintotal cost C hangeinqu antity = T C Q
- 34. Harcourt Brace & Company Marginal Cost Quantity Total Cost Marginal Cost Quantity Total Cost Marginal Cost 0 $3.00 — 1 3.30 $0.30 6 $7.80 $1.30 2 3.80 0.50 7 9.30 1.50 3 4.50 0.70 8 11.00 1.70 4 5.40 0.90 9 12.90 1.90 5 6.50 1.10 10 15.00 2.10
- 35. Harcourt Brace & Company Quick Quiz! Ford’s total cost of producing 4 cars is $225,000 and its total cost of producing 5 cars is $250,000.
- 36. Harcourt Brace & Company Quick Quiz! What is the average total cost and marginal cost of producing the fifth car?
- 37. Harcourt Brace & Company Cost Curves and Their Shapes Marginal cost rises with the amount of output produced. ä At low levels of output, an increase in production will occur at a relatively small cost. ä Increasing output is more costly when the amount being produced is already high.
- 38. Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 1 4 3 2 7 6 5 9 8 14 13 12 11 10
- 39. Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 1 4 3 2 7 6 5 9 8 14 13 12 11 10 MC
- 40. Harcourt Brace & Company Cost Curves and Their Shapes The average total-cost curve is U- shaped. ä At very low levels of output average total cost is high because fixed cost is spread over only a few units. ä Average total cost declines as output increases. ä Average total cost starts rising because average variable cost rises substantially.
- 41. Harcourt Brace & Company Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 1 4 3 2 7 6 5 9 8 14 13 12 11 10
- 42. Harcourt Brace & Company Cost Curves and Their Shapes Quantity of Output (bagels per hour) Costs $3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 1 4 3 2 7 6 5 9 8 14 13 12 11 10 ATC AVC AFC
- 43. Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising.
- 44. Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost The marginal-cost curve crosses the average-total-cost curve at the efficient scale. ä Efficient scale is the quantity that minimizes average total cost.
- 45. Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost Quantity of Output (bagels per hour) Costs $3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 1 4 3 2 7 6 5 9 8 14 13 12 11 10
- 46. Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost Quantity of Output (bagels per hour) Costs $3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 1 4 3 2 7 6 5 9 8 14 13 12 11 10 ATC
- 47. Harcourt Brace & Company Relationship Between Marginal Cost and Average Total Cost Quantity of Output (bagels per hour) Costs $3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00 0.75 0.50 0.25 0 1 4 3 2 7 6 5 9 8 14 13 12 11 10 MC ATC
- 48. Harcourt Brace & Company Costs in the Long Run For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered. ä In the short run some costs are fixed. ä In the long run fixed costs become variable costs.
- 49. Harcourt Brace & Company Costs in the Long Run Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.
- 50. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Economies of scale occur when long- run average total cost falls as the quantity of output increases.
- 51. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Diseconomies of scale occur when long-run average total cost rises as the quantity of output increases.
- 52. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Constant returns to scale occur when long-run average total cost stays the same as the quantity of output increases.
- 53. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost
- 54. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory
- 55. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory ATC in short run with medium factory
- 56. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory
- 57. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost
- 58. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost ATC in long run
- 59. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost Economies of scale ATC in long run
- 60. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost Economies of scale ATC in long run Constant returns to scale
- 61. Harcourt Brace & Company U-Shaped Long-Run Average Total Cost Quantity of Cars per Day 0 Average Total Cost Economies of scale ATC in long run Diseconomies of scale Constant returns to scale
- 62. Harcourt Brace & Company Quick Quiz! When Boeing produces 9 jets per month, its long-run total cost is $9.0 million per month.
- 63. Harcourt Brace & Company Quick Quiz! When Boeing produces 10 jets per month, its long-run total cost is $9.5 million per month.
- 64. Harcourt Brace & Company Quick Quiz! Does Boeing exhibit economies or diseconomies of scale?
- 65. Harcourt Brace & Company Conclusion The goal of firms is to maximize profit, which equals total revenue minus total cost. Some costs are explicit. Other costs, such as opportunity costs, are implicit. A firm has fixed and variable costs. Fixed costs don’t vary with quantities produced; variable costs do.
- 66. Harcourt Brace & Company Conclusion Average total cost is total cost divided by the quantity of output. Marginal cost is the amount total cost rises if output is increased by one unit. Marginal cost generally rises with the quantity of output; average total cost first falls as output increases and then eventually rises with further output.
- 67. Harcourt Brace & Company Conclusion A firm’s costs often depend on the time horizon being considered. Many costs are fixed in the short run but variable in the long run. When the level of production changes, average total cost may rise more in the short run than in the long run.
- 68. Harcourt Brace & Company THE COSTS OF PRODUCTION End of Chapter 13