31
Principles of Microeconomics Module 4 Understanding Production Costs

Understanding Production Costs - · PDF filefixed cost variable cost total cost ... production costs outpu t fixed cost variable cost ... marginal cost outp ut fixed cost variable

  • Upload
    vantram

  • View
    257

  • Download
    5

Embed Size (px)

Citation preview

PrinciplesofMicroeconomicsModule4

UnderstandingProductionCosts

FirmDecisions:ShortRunandLongRun• Afirm’sdecisionsaregroupedas:– Short-rundecisions– timehorizonoverwhichatleastoneofthefirm’sinputscannotbevaried– Long-rundecisions– timehorizonlongenoughforafirmtovaryallofitsinputs

• UsesaProductionFunctiontodeterminehowmuchoutputitwillproducefromagivencombinationofinputs

Example:Q=100K+25L

Ifthefirmincreasescapital(K)itwillincreaseproduction(Q)Ifthefirmincreaseslabor(L)itwillincreaseproduction(Q)

Production Function

ShortRun:Atleastoneinputisfixed– Fixedinputs:Land,machinery,laborwithcontracts– Variableinputs:Labor,energy,fuel

LongRun:Allinputsarevariable– thefirmcanchangetheamountofeachinputthattheyuse

Production Function

Total Product• Totalproduct:Maximumquantityofoutputthatcanbeproducedfromagivencombinationofinputs

• Thetotalproductcurveshowshowthequantityofoutputdependsonthequantityofvariableinput,foragivenquantityofthefixedinput.

Total Product • AssumeFirmAhasonlyonevariableinput:Labor.• Allotherinputsarefixed.

Labor TotalProduct=Output

0 0

1 50

2 90

3 120

4 140

5 150

7 150

Total Product Curve• Witheachadditionalinput:FirmAproducesmoreoutput

• TotalProductCurveisincreasing

01234567

150

140

130

120

90

50

0

TotalTotalProduct

Marginal Product

Marginal Product of Labor

Labor Output MPL0 01 502 903 1204 1405 1507 150

Marginal Product of Labor

Labor Output MPL0 01 50 +502 90 +403 120 +304 140 +205 150 +107 150 +0

Diminishing Marginal Returns to LaborOutput isincreasingatadecreasingrateiffirmincreasesonlyoneinputEachworkeraddstoproduction, but lessandless

Labor Output MPL0 01 50 502 90 403 120 304 140 205 150 106 150 0

01234567

150

140

130

120

90

50

0

TotalTotalProduct

Production Choices of Firms• Allfirmshaveonegoalinmind:MAXPROFITS

PROFITS=TOTALREVENUE– TOTALCOST

• Twowaystoreachthisgoal:– Maximizetotalrevenue

TotalRevenue=PriceXQuantity– Minimizetotalcosts

TotalCosts=FixedCosts+VariableCosts

Production Costsfor Firms

• FixedCosts:Coststhatstaythesameregardlessofhowmuchafirmproduces

• Example:Rentpaidforastorelocation

Production Costs for Firms • VariableCosts:Coststhatchangebasedonhowmuchafirmproduces– Themorethefirmproduces,themorematerials,workers,inputsithastoemploy– Thecostofthoseinputsarevariablecosts

• Example:WagespaidtoemployeesCostofmaterials

Production Costs for Firms

• TotalCosts:Sumoffixedandvariablecosts– Totalcostsfacedbythefirmtoproduce

• Example:Rent+Wages+CostofInputs

Test your UnderstandingSupposeafirmhastopayarentalpriceof$800foramachineitusesinproduction.Italsopaysitsworkers$25each.Canyoucompletethefollowingtable?

Machines Workers CostofCAPITAL(FixedCost)

CostofLABOR(VariableCost) TOTALCOST

1 5

1 10

1 15

1 20

1 25

1 30

Test your UnderstandingRentPriceofCapital=$800à FIXEDCOSTWagesofworkers=$25à VARIABLECOST

Machines Workers CostofCAPITAL(FixedCost)

CostofLABOR(VariableCost) TOTALCOST

1 5 800 125 925

1 10 800 250 1050

1 15 800 375 1175

1 20 800 500 1300

1 25 800 625 1425

1 30 800 750 1550

How Firms Analyze Production CostsToanalyzetheproductiondecisionsofafirm,recallthatafirmconducts“marginalanalysis”Decisionsarebasedonper-unitcalculations

Therefore, needtocalculatecosts/unit:

AverageVariableCost(AVC)=VariableCost/Quantityproduced

AverageFixedCost(AFC)=FixedCost/Quantityproduced

AverageTotalCost(ATC)=TotalCost/Quantityproduced

Production Costs

OUTPUT

FIXEDCOST

VARIABLECOST

TOTALCOST AFC AVC ATC

100 800 125 925200 800 150 950250 800 175 975

TC/QVC/QFC/Q

Costsperunitofoutputproduced

AverageCostCurves

QuantityProduced

Cost

ProductionCosts

OUTPUT

FIXEDCOST

VARIABLECOST

TOTALCOST AFC AVC ATC

100 800 125 925 8.00 1.25 9.25200 800 150 950 4.00 1.25 5.25250 800 175 975 3.20 1.50 4.70

TC/QVC/QFC/Q

Costsperunitofoutput

produced

Marginal Cost

OUTPUT

FIXEDCOST

VARIABLECOST

TOTALCOST AFC AVC ATC MC

100 800 125 925 8.00 1.25 9.25200 800 150 950 4.00 1.25 5.25250 800 175 975 3.20 1.50 4.70

MarginalCost:ChangeinTotalCostwhenproducingonemoreunitofthegood

MC=(TC2- TC1)/(Q2-Q1)

Marginal Cost

OUTPUT

FIXEDCOST

VARIABLECOST

TOTALCOST AFC AVC ATC MC

100 800 125 925 8.00 1.25 9.25200 800 150 950 4.00 1.25 5.25 1.25250 800 175 975 3.20 1.50 4.70 2.5

MarginalCost:ChangeinTotalCostwhenproducingonemoreunitofthegood

MC=(TC2- TC1)/(Q2-Q1)

Marginal Cost Curve

QuantityProduced

Cost

Long Run vs. Short Run Total Cost• Intheshortrun:firmhasbothfixedandvariablecosts– Managersmustconsiderthefirmshoulddooverthecourseofthenextweek

• Inthelongrun:allcostsarevariablebecauseallinputsarevariableandcanchange– Managershavealong-termviewwhenconsideringwhatthefirmshoulddointhecomingyears

Costs in the Long Run

AverageTotalCost(Costpercoffeesold)

100Customers

200Customers

300Customers

400Customers

1Location 0.50 0.45 0.55 0.75

2Locations 0.65 0.40 0.60 0.70

3Locations 0.75 0.65 0.50 0.45

Considerasmallcoffeeshop,wherethemajorityofcustomerscomeintobuytheirdailycupofcoffee.Currently,theshopservesabout200customersandhasonlyonelocation.It’sconsideringwhetherornottoexpand.

LongRunvs.ShortRunTotalCost

SRATC1 SRATC2 SRATC3 LRATC1

Output

ATC

EconomiesofScale:ATCisfallingwithincreaseinoutput

LongRunvs.ShortRunTotalCost

SRATC1 SRATC2 SRATC3 LRATC1

Output

ATC

ConstantReturnstoScale:ATCisthesame

LongRunvs.ShortRunTotalCost

SRATC1 SRATC2 SRATC3 LRATC1

Output

ATC

DiseconomiesofScale:ATCisrisingwithincreaseinoutput

Economies of Scale1. IncreasingReturnstoScale(Economiesofscale):

Occursdueto:• Gainsfromspecialization• Minimumsizerequirementsforcertaintypesofequipment.

2. ConstantReturnstoScale:OutputrangewithconstantLRATC

• Sizemaynotmatterandfirmsofthesamesizewillbeequallycost-effective.

3. DecreasingReturnstoScale(Diseconomiesofscale):Firmsreachapointwherebignessbeginstocauseproblems• Onereallylargecoffeeshopserving400+customers• Diseconomiesofscalearemorelikelyathigheroutputlevels

Key Takeaways• Allfirmsareprofitmaximizingandthereforewanttominimizetheircosts

• Tomaketheirproductiondecisions– needtoconsiderATC,AVC,AFCandMC

• NEXT:Mergecostcurveswithrevenuetounderstandhowdifferenttypesoffirmsmakeproductiondecisions