Ch Cost Concept

8/22/2019 Ch Cost Concept

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The Firm:

Cost and Output Determination


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Learning Objectives

Discuss the difference between the short run and the long

run from the perspective of a firm

Understand why the marginal physical product of laboreventually declines as more units of labor are employed

Explain the short-run cost curves a typical firm faces

Describe the long-run cost curves a typical firm faces

Identify situations of economies and diseconomies of scale


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Did You Know That...

Production technologies and the costsproducers face are related?


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Short Run

A time period when at least one input, such as

plant size, cannot be changed

Plant Size

The physical size of the factories that a firm owns

and operates to produce its output

Short Run versus Long Run


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Long Run

The time period in which all factors of

production can be varied


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Managers take account of both the short-run

and long-run consequences of their

behavior.

While making decisions about what

to do today, tomorrow, and next week

they keep an eye on the long-run benefits.


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The Relationship Between

Output and InputsA firm takes numerous inputs, combines

them using a technological production

process and ends up with output.

We classify production inputs in two broad

categorieslabor and capital.


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Output and Inputs

Q = output/time periodK= capital

L = labor

Q =(K,L)

or

Output / time period = Some function of capital and labor inputs


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Output and InputsProduction

Any activity that results in the conversion of

resources into products that can be used in

consumption


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Output and InputsProduction Function

The relationship between maximum physical

output and the quantity of capital and labor

used in the production process

The production function is a technological

relationship between inputs and output.


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E-Commerce Example:

Put Away the Clay and Turn on

the Holographic Camera

Once a company has integrated aholographic camera system into its existing

computer network, creating holographicdesigns takes less time.

Consequently, product developers using

holographic techniques can now createmore designs while utilizing fewer laborresources.


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E-Commerce Example:

Put Away the Clay and Turn on

the Holographic Camera

Why do technological improvements often

reduce labor requirements for specific tasks,thereby allowing labor to be utilized for

other purposes?


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Output and InputsAverage Physical Product

Total product divided by the variable input


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Output and InputsMarginal Physical Product

The physical output that is due to the addition

of one more unit of a variable factor ofproduction

The change in total product occurring when a

variable input is increased and all other inputsare held constant

Also called marginal product


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The Production

Function and

MarginalProduct:

A Hypothetical

Case, Panel (a)


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The Production

Function and Marginal Product:

A Hypothetical Case


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The Production

Function and Marginal Product:

A Hypothetical Case


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Diminishing Marginal Product

Measuring marginal product

Specialization and marginal product

Diminishing marginal product


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Law of Diminishing Marginal Product

The observation that after some point,

successive equal-sized increases in a variable

factor of production, such as labor, added to

fixed factors of production, will result in

smaller increases in output

Diminishing Marginal

Product


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An Example of the Law of

Diminishing Marginal ProductProduction of computer

printers example

We have a fixed amount of factory space,assembly equipment, and quality controldiagnostic software.

So the addition of more workerseventually yields successively smaller increasesin output.


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An Example of the Law of

Diminishing Marginal ProductAfter a while, when all the assembly equipment

and quality-control diagnostic software are being

used, additional workers will have to start

assembling and troubleshooting quality problems

manually.

The marginal physical product of an additional

worker, given a specified amount of capital, musteventually be less than that for the previous

workers.


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Total costs (TC) = TFC + TVC

Short-Run Costs to the Firm

Total Costs

The sum of total fixed costs and totalvariable costs

Fixed Costs

Costs that do not vary with output

Variable Costs

Costs that vary with the rate of production


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Average Total Costs (ATC)


Average total costs (ATC) = Total costs (TC)Output (Q)


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Average Variable Costs (AVC)


Average variable costs (AVC) =Total variable costs (TVC)

Output (Q)


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Average Fixed Costs (AFC)


Average fixed costs (AFC) = Total fixed costs (TFC)Output (Q)


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Marginal Cost

The change in total costs due to a one-unit

change in production rate


Marginal costs (MC) =Change in total cost

Change in output


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Cost of Production: An Example


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Question

What do you thinkis there a predictable

relationship between the production function

and AVC, ATC, and MC?


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Answer

As long as marginal physical product rises,

marginal cost will fall, and when marginal

physical product starts to fall (after reaching the

point of diminishing marginal product),

marginal cost will begin to rise.


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Average and Marginal CostsWhen marginal costs are less than average

variable costs, the latter must fall.

When marginal costs are greater than

average variable costs, the latter must rise.


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Average and Marginal CostsThere is also a relationship between

marginal costs and average total costs.

Average total cost is equal to total cost divided

by the number of units produced.

Marginal cost is the change in total

cost due to a one-unit change in the production

rate.


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The Relationship Between Diminishing

Marginal Product and Cost Curves

Firms short-run cost curves are a reflection

of the law of diminishing marginal product.

Given any constant price of the variable

input, marginal costs decline as long as the

marginal product of the variable resource is

rising.


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At the point at which diminishing marginal

product begins, marginal costs begin to rise

as the marginal product of the variable inputbegins to decline.




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If the wage rate is constant, then the labor

cost associated with each additional unit of

output will decline as long as the marginalphysical product of labor increases.


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The Relationship Between Output

and Costs

/ / /


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and Costs


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and Costs


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and Costs


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Long-Run Cost Curves

Planning Horizon

The long run, during which all inputs

are variable


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Preferable Plant Size and the

Long-Run Average Cost Curve


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Long-Run Average Cost Curve

The locus of points representing the minimum

unit cost of producing any given rate of output,

given current technology and resource prices


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Observation

Only at minimum long-run average cost curve

is short-run average cost curve tangent to long-run average cost curve.

Question

Why do you think the long-run average cost

curve is U-shaped?


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Why the Long-Run Average

Cost Curve is U-Shaped

Economies of scale

Constant returns to scale

Diseconomies of scale

Economies of Scale Constant Returns


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Economies of Scale, Constant Returns

to Scale, and Diseconomies of Scale

Shown with Long-Run Average CostCurve


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Economies of Scale

Decreases in long-run average costs resulting

from increases in output

These economies of scale do not persist indefinitely,

however.

Once long-run average costs rise, the curve begins

to slope upwards.


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Reasons for economies of scale

Specialization

Division of tasks or operations

Dimensional factor

Improved productive equipment




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Explaining diseconomies of scale

Limits to the efficient functioning

of management

Coordination and communication is more of a

challenge as firm size increases

S Di i


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Summary Discussion

of Learning Objectives

The short run versus the long run from a

firms perspective

Short runa period in which at least one input

is fixed

Long runa period in which all inputs

are variable

S Di i


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Summary Discussion


The law of diminishing marginal product

As more units of a variable input are employed with a

fixed input, marginal physical product eventuallybegins to decline.

A firms short-run cost curves

Fixed and average fixed cost

Variable and average variable cost

Total and average total cost

Marginal cost


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Summary Discussion


A firms long-run cost curve

Planning horizonAll inputs are variable including plant size

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Ch Cost Concept