Economics For Managers GTU MBA Sem 1 Chapter 13

7/31/2019 Economics For Managers GTU MBA Sem 1 Chapter 13

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A Firms Total Revenue and

Total Cost

xTotal Revenuex The amount that the firm receives for

the sale of its output.

xTotal Costx The amount that the firm pays to buy

inputs.


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A Firms Profit

Profit is the firms total revenue minus

its total cost.

Profit = Total revenue - Total cost


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Costs as Opportunity Costs

A firms cost of productionincludes all the opportunity

costs of making its output of

goods and services.


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Explicit and Implicit Costs

A firms cost of production include

explicit costs and implicit costs.xExplicit costs involve a direct money

outlay for factors of production.

xImplicit costs do not involve a directmoney outlay.


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Economic Profit versus Accounting Profit

x Economists measure a firms economic profitas total revenue minus all the opportunity costs(explicit and implicit).

x Accountants measure the accounting profit as

the firms total revenue minus only the firmsexplicit costs. In other words, they ignore theimplicit costs.

x When total revenue exceeds both explicit andimplicit costs, the firm earns economicprofit.x Economic profit is smaller than accounting

profit.


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Economic Profit versus

Accounting Profit


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The Production Function

The production function shows therelationship between quantity of

inputs used to make a good and

the quantity of output of thatgood.


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Marginal Product

sThe marginal product of any

input in the production process is

the increase in the quantity of

output obtained from an additional

unit of that input.

Additional input

Additional output=Marginalproduct


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Diminishing Marginal Product

xDiminishing marginal product is the

property whereby the marginal product of an

input declines as the quantity of the input

increases.

xExample: 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.


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A Production Function...

150

140

130

120

110

100

90

80

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6050

40

30

20

10

0 1 2 3 4 5


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Diminishing Marginal Product

xThe slope of the production function

measures the marginal product of

an input, such as a worker.

xWhen the marginal product

declines, the production functionbecomes flatter.


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From the Production Function to

the Total-Cost Curve

xThe relationship between the

quantity a firm can produce and itscosts determines pricing decisions.

xThe total-cost curve shows this

relationship graphically.


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Total-Cost Curve...


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Fixed and Variable Costs

xFixed costs are those costs that do not

vary with the quantity of output

produced.

xVariable costs are those costs that do

change as the firm alters the quantityof output produced.


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Family of Total Costs

xTotal Fixed Costs (TFC)

xTotal Variable Costs (TVC)xTotal Costs (TC)

TC = TFC + TVC


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Family of Total Costs

Quantity Total Cost Fixed Cost Variable Cost

0 $ 3.00 $3.00 $ 0.001 3.30 3.00 0.302 3.80 3.00 0.803 4.50 3.00 1.504 5.40 3.00 2.405 6.50 3.00 3.50

6 7.80 3.00 4.807 9.30 3.00 6.308 11.00 3.00 8.009 12.90 3.00 9.90

10 15.00 3.00 12.00


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Average Costs

xAverage costs can be determined by

dividing the firms costs by the

quantity of output produced.

xThe average cost is the cost of each

typical unit of product.


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Family of Average Costs

xAverage Fixed Costs (AFC)

xAverage Variable Costs (AVC)

xAverage Total Costs (ATC)

ATC = AFC + AVC


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AFC =Fixed cost

Quantity=

FC

Q

AVC =Variable cost

Quantity=

VC

Q

ATC =Total cost

Quantity=

TC

Q

AFC =Fixed cost

Quantity=

FC

Q

AVC =Variable cost

Quantity=

VC

Q

ATC =Total cost

Quantity=

TC

Q


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$3.00


Quantity AFC AVC ATC0 1 $0.30 $3.302 1.50 0.40 1.90

3 1.00 0.50 1.504 0.75 0.60 1.355 0.60 0.70 1.306 0.50 0.80 1.307 0.43 0.90 1.338 0.38 1.00 1.389 0.33 1.10 1.43

10 0.30 1.20 1.50


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Marginal Cost

xMarginal cost (MC) measures the

amount total cost rises when the firm

increases production by one unit.xMarginal cost helps answer the

following question:

x How much does it cost to produce anadditional unit of output?


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Marginal Cost


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Marginal Cost

Quantity TotalCost

MarginalCost

Quantity TotalCost

MarginalCost

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 1.905 6.50 1.10 10 15.00 2.10


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Total-Cost Curve...

Quantity of Output

(glasses of lemonade per hour)


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Average-Cost and Marginal-Cost

Curves...


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Cost Curves and Their Shapes

Marginal cost rises with the

amount of output produced.xThis reflects the property of

diminishing marginal product.


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The average total-cost curve is U-shaped.

x At very low levels of output average total cost is

high because fixed cost is spread over only a fewunits.

x Average total cost declines as output increases.

x

Average total cost starts rising because averagevariable cost rises substantially.


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The bottom of the U-shape occurs at

the quantity that minimizes average

total cost. This quantity is sometimes

called the efficient scale of the firm.


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Relationship Between Marginal

Cost and Average Total Cost

xWhenever marginal cost is less than

average total cost, average total cost

is falling.

xWhenever marginal cost is greater

than average total cost, average totalcost is rising.


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The marginal-cost curve crosses

the average-total-cost curve at

the efficient scale.

x

Efficient scale is the quantitythat minimizes average total cost.


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The Various Measures of Cost

It is now time to examine therelationships that exist between the

different measures of cost.


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Three Important Properties of

Cost Curves

xMarginal cost eventually rises with

the quantity of output.

xThe average-total-cost curve is U-

shaped.

x

The marginal-cost curve crosses theaverage-total-cost curve at the

minimum of average total cost.


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Costs in the Long Run

xFor many firms, the division of total

costs between fixed and variable costs

depends on the time horizon beingconsidered.

x In the short run some costs are fixed.

x

In the long run fixed costs become variablecosts.


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Costs in the Long Run

Because many costs are fixed in

the short run but variable in the

long run, a firms long-run cost

curves differ from its short-run

cost curves.


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Average Total Cost in the Short

and Long Runs...


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Economies and Diseconomies

of Scale

x Economies of scale occur when long-run

average total cost declines as output

increases.

x Diseconomies of scale occur when long-

run average total cost rises as output

increases.

x Constant returns to scale occur when

long-run average total cost does not

vary as output increases.

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Economics For Managers GTU MBA Sem 1 Chapter 13