Chapter 9 Businesses and the Cost of Production

Chapter 9 Businesses and the Cost of Production Copyright © 2015 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Economic Costs • The payment that must be made to obtain and LO 1 retain the services of a resource • Explicit costs • Monetary outlay • Implicit costs • Opportunity cost of using self-owned resources • Value of next-best use • Includes a normal profit 9 -2

Accounting Profit and Normal Profit • Accounting profit = Total revenue – explicit costs • Economic profit = Accounting profit – implicit costs • Economic profit (to summarize) = Revenue – economic cost = Revenue – explicit costs – implicit costs LO 1 9 -3

Short Run and Long Run • Short run • Some variable inputs • Fixed plant • Long run • All inputs are variable • Firms can adjust plant size as well as enter and exit industry LO 2 9 -4

Short Run Production Relationships • Total product (TP) • Marginal product (MP) Marginal product = change in total product change in labor input • Average product (AP) Average product = LO 2 total product units of labor 9 -5

Law of Diminishing Returns • Law of diminishing returns • Resources are of equality • Technology is fixed • Variable resources are added to fixed resources • At some point, marginal product will fall • Rationale LO 2 9 -6

Short Run Production Costs • Fixed costs (TFC) • Costs that do not vary with output • Variable costs (TVC) • Costs that do vary with output • Total cost (TC) • Sum of TFC and TVC • TC = TFC + TVC LO 3 9 -7

Per-Unit, or Average, Costs • • LO 3 Average fixed cost Average variable cost Average total cost Marginal cost AFC = TFC/Q AVC = TVC/Q ATC = TC/Q MC = ΔTC/ΔQ 9 -8

Long Run Production Costs • The firm can change all input amounts, including plant size • All costs are variable in the long run • Long run ATC • Different short run ATCs LO 4 9 -9

Economies of Scale • Economies of scale • Labor specialization • Managerial specialization • Efficient capital • Other factors • Constant returns to scale LO 4 9 -10

Diseconomies of Scale • Diseconomies of scale • Control and coordination problems • Communication problems • Worker alienation • Shirking LO 4 9 -11

MES and Industry Structure • Minimum efficient scale (MES) • Lowest level of output at which long run average costs are minimized • Can determine the structure of the industry • Natural monopoly • Long run costs are minimized when one firm produces the product LO 4 9 -12