chapter eight costs and the changes at firms over time
TRANSCRIPT
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Intro
• Purpose of chapter is to develop a model for analyzing when a firm decides to maintain, shut down, or expand their production process.
• Costs determine how large firms should be.– Economists can capture the whole essence of a firm with
a graph of its costs.• Can determine the profitability of a firm and whether it should
shut down or expand.
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Finding Average Cost at an Individual Firm
• Total Costs: Sum of variable costs and fixed costs– The more that is produced, the larger total costs will be.
• Fixed Costs: The part of total costs that do not vary with the amount produced in the short run– Examples include land, factories, and machines
• Variable Costs: The costs of production that vary with the quantity produced– Examples include wages and gasoline for trucks
TC = FC + VC
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Short Run and the Long Run
• Short Run: Period of time during which it is not possible to change all inputs to production. Only some inputs, like labor, can be changed.– Can’t build factory in the short run
• Long Run: The minimum period of time during which all inputs to production can be changed
• Frequent examples of short run and long run– Capital can NOT change in the short run– Labor CAN change in the short run
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Average and Marginal Cost
Q TC FC VC ATC AFC AVC MC
0 300 300 0 -- -- -- --
1 450 300 150 450 300 150 150
2 570 300 270 285 150 135 120
3 670 300 370 223 100 123 100
4 780 300 480 195 75 120 110
5 900 300 600 180 60 120 120
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Figure 8.1: Fixed Costs versus Variable Costs
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Figure 8.2: Total Costs Minus Fixed Costs Equal Variable Costs (For On-The-Move)
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Marginal Cost
• The change in total costs due to a one-unit change in quantity produced.– In other words, how much does cost go up when you
produce one more unit
• Marginal cost declines in very low levels of production, but then increases as production increases
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Average Cost
• Average Total Cost (ATC): Total costs of production divided by the quantity produced – Also referred to as Cost Per Unit– ATC = TC/Q
• Average Variable Cost (AVC): Variable costs divided by the Quantity– AVC = VC/Q
• ATC decreases at first, then increases as production rises
• AVC decreases at first, then increases as production rises
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Costs Depend on the Firm’s Production Function
• Production Function: Relationship that shows the quantity of output for any given amount of input
• Marginal Product of Labor: Change in production that can be obtained with an additional unit of labor– Decreasing marginal product of labor = Diminishing
Returns to Labor– Increasing marginal product of labor = Increasing
Returns to Labor
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Figure 8.3: On-the-Move's Production Function
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Production Function
• Increasing marginal product of labor = Decreasing marginal cost
• Decreasing marginal product of labor = Increasing marginal cost
• Average Product of Labor = The quantity produced divided by the amount of labor input– APL = Q/L– Marginal Product of Labor = ΔQ/ΔL
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Figure 8.4: Average Cost and Marginal Cost from a Numerical Example
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Average Cost Curves
• Average Cost Curves (ATC, AVC) are both U-shaped
• Lowest point of ATC and AVC are where they intersect the MC curve
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Figure 8.5: Generic Sketch of Average Cost and Marginal Cost
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Costs and Production: The Short Run
• If a firm is maximizing profits, it will choose to produce a quantity where price = marginal cost
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Figure 8.6: Price Equals Marginal Cost
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Figure 8.7: Showing Profits on the Cost Curve Diagram
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Figure 8.8: Showing a Loss on the Cost Curve Diagram
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The Breakeven Point
• The Breakeven Point is where price equals the minimum of average total cost (ATC)
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Figure 8.9: The Breakeven Point
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The Shutdown Point
• A firm should shut down when the price falls below the minimum point of the average variable cost curve and is not expected to rise again.
• Two Important Points:– Shutdown point: P = Minimum AVC– Breakeven point: P = Minimum ATC
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Figure 8.10: The Shutdown Point
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Costs and Production: The Long Run
• All costs can be adjusted in the long run• If a firm increases its capital (factories, for example)
– Fixed costs will rise– Variable costs decline
• What happens to Total Cost?– New total cost will be higher at low levels of output
(fixed costs dominate)• ATC will also be higher at low levels
– New total cost will be lower at high levels of output (variable costs dominate)
• ATC will be lower at high levels
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Figure 8.11: Shifts in Total Costs as a Firm Increases Its Capital
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Figure 8.12: Shifts in Average Total Cost Curves When a Firm Expands Its Capital
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Long-run ATC Curve
• The Long-Run Average Total Cost Curve is the curve that connects the short-run ATC curves at the lowest ATC for each quantity produced as the firm expands in the long run
• Remember: A firm will always act to maximize profits
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Figure 8.13: Long-Run versus Short-Run Average Total Cost
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Economies of Scale
• When all inputs to production increase, we say that the SCALE of the firm increases.– Long run ATC describes what happens to a firm’s ATC when its
scale increases
• Economies of Scale (Increasing Returns to Scale): Situation in which long run ATC decreases as output increases
• Diseconomies of Scale (Decreasing Returns to Scale): Situation in which long run ATC increases as output increases
• Constant Returns to Scale: Situation in which long run ATC is constant as the output changes
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Economies of Scale
• The long run ATC for most firms declines at low levels of output, then remains flat, and finally increases at high levels of output– As a firm gets very large, administrative expenses,
coordination, and incentive problems, will begin to raise ATC.
• Minimum efficient scale: The smallest scale of production for which long-run ATC is at a minimum.
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Figure 8.14: Economies and Diseconomies of Scale
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Figure 8.15: Typical Shape of the Long-Run Average Total Cost Curve
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Mergers and Economies of Scope
• If product lines of 2 firms are similar, then such mergers may be a way to reduce costs. – Example: Exxon and Mobil– Also merge to combine different skills or resources to
develop new products
• Combining different types of firms to reduce costs or create new products is called ECONOMIES OF SCOPE.