cvpjnh mhj jh jh jh jhmhjmhj
TRANSCRIPT
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Chapter 5
Revenue
and
costs
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Introduction
Key terms
Equilibriumprice
DemandSide Supply Side
Short run longrun
Revenue
TotalRevenue
AverageRevenue
MarginalRevenue
Cost
Total costAverage
costMarginal
cost
Economiesand
diseconomies
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Key terms
Equilibrium Price:- Price at which quantity
demanded is equal to Quantity supplied.
Demand:- Quantity which a person is ready to
purchase and having need on that particular price
in that particular time period.
Supply:- Quantity of goods which a person is
ready and willing to sell at a given price and at a
given time period.
Cost:- Amount of money spend to produce goods.
Revenue:- Amount of money earned after selling
the production.
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Before starting
revenue and costs
, lets revise
equilibrium price.
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EquilibriumPrice
Price at which quantity demanded and quantitysupplied.
y
xO
D
D
S
S
E
Quantity demanded
and supplied
Price
So, it has both :-
Demand side
Supply side
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So, this chapteris devoted
to a more detailed analysisof the supply sideof the
picture. Both the conceptsrevenue and costsare
related to the supply side.
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Revenue
Earnings of the firmfrom the
sales of its output is called
revenue.
E.g.A seller selling 20 units of the
commodity at Rs. 20 will havetotal revenue as Rs. 400
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Types of revenue
Total
RevenueTotal
earnings
from sales
over a
certainperiod of
time.
TR=P*Q
Average
RevenueRevenue per
unit sold.AR=TR/Q
Marginal
RevenueChange in
revenue
when output
changes by
one unit.MR=TRn+1-
TRn
MR=TR/Y.
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Revenue schedule
Table showingthe relationbetweenoutput and the
revenue(s).
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Revenue scheduleAmount of
outputsold(units)
Price or AR (Rs.) TR (Rs.)
TR=P*Q
MR(Rs.)
MR=TRn+1-TRnMR=
TR/
Y
0 30 0 -
1 29 29 29
2 27 54 25
3 24 72 18
4 20 80 8
5 16 80 0
6 12 72 -8
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Relation between AR and price
AR=TR/Q
AR=P*Q/Q=PSo, ARisnothing but the
priceitself.
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Distinction between demand and revenue
schedule
The demand schedule and the revenueschedules are interlinked. Yet they are not
identical.
Because AR=P, The relationshipbetweenquantity and priceis, of course, the same as
the relationbetween quantity and average
revenue.
We will derive the revenue from the demand
schedule.
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XO
Y
D
D
E
F
A
B
C
H
Quantity
Price
We are given the demand curve
DD for the product a firm.
For drawing the revenue curve,
we have to show the total
revenue at the different levels
of output
At OB, revenue= OA*OB=OAEB
At OH, revenue= OC*OH=OCFH
In this way , from the demand
curve , we can calculate total
revenue at all levels of output.
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Total revenue curve
O X
Y
TR
A
Quantity
Total
revenue
Total revenue rises
when output
increases reaches tothe maximum and
after that start
falling.
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TR and elasticity of demand
Price elasticity of
demand
Price and Quantity
movements (P falls
Q rises)
Change in TR
Elastic (ep>1) % rise in Q > % fall
in P
TR rises
Unitary elastic(ep=1)
% rise in Q > % fallin P
TR remainsunchanged
Inelastic (ep % fall
in P
TR falls
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O
P
Q
Ep =1
Ep=
Ep=0
Ep>1
Ep>1
Quantity
Price
O
P
QQuantity
P
rice
Moreelas
tic
TRrises
Unitary elastic
TR
maximum
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Relation between Total, Average and
Marginal revenue
Relation among TR,AR,MR is shown under two
market situations:-
When the firm
sells its
product at agiven price.
When the firmsells its
product moreat a reducing
price.
Wh h fi ll i d i
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When the firm sells its product at a given
price
Output Price Totalrevenue
Averagerevenue
Marginalrevenue
1 5 5 5 5
2 5 10 5 5
3 5 15 5 5
4 5 20 5 5
5 5 25 5 5
It is called a perfectly competitive market.
Price is determined by industry.
O
Y
X
AR=MR
TR
Quantity
Reve
nue
P
Wh h fi ll i d
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When the firm sells its product more at a
reducing price.
Output Price Total
Revenue
Average
Revenue
Marginal
Revenue
1 10 10 10 10
2 9 18 9 8
3 8 24 8 6
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
8 3 24 3 -4
O
Y
X
P
TR
AR
MR
TR ismaximum
MR is zero
Output
Reve
nue
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Relation between AR and MR and
Price elasticity of demand Ed= lower portion /
upper portion
=AN/MA
=PO/MP (BPT Theorem)
=PO/AC (MPB ABC)
=AQ/AC
=AR/AR-MR
O
Y
X
M
NQ
P A
C
B
MR
AR=P
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Each firm uses various inputs (resources) in itsproduction activity.
Commonly used inputs: labor and capital
Prices of inputs (wages, rents) Cost of Production
The Cost of Production
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Cost Concepts
Private cost:- the cost of production borne by proprietor or
partners can be termed as private cost. Eg cost of
producing steel by tata steel company.
Social cost:- the sacrifice that the members of society have
to bear for carrying out production. Eg water , air pollution Money cost:- the cost of production which is mesured in
terms of money. E.g. Cost of RAW material.
Real cost:- the cost expressed in terms of the volume of
inputs required to produce a particular quantity of output.
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Explicit and Implicit Costs
Explicit Costs : The money payment that a
firm makes to the outsiders who supply
inputs.These are the out of pocket costs.
Eg. Salaries, price paid for raw material,
components etc.Explicit cost is also known as money cost or
accounting cost.
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Implicit Costs : The costs of the self
owned resources which are employed
by the firm and are nonexpenditure
costs.
Eg. Salary of the proprietor, interest on
the entrepreneurs own investment etc. It is also known as opportunity cost.
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Economic costs
The costs of production which take into
account both explicit cost and opportunity or
implicit costs can be considered as economic
costs of production.
Economic cost= implicit cost + explicit cost+
normal profits
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Normal profit
The normal profit means the minimum
income which accrue to an entrepreneur in
order to induce him for undertaking risk
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Costs that are fixed in the short run may not be
fixed in the long run.
Typically in the long run, most if not all costs are
variable.
Short period and long period
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Short run and long run cost
The short run period implies that period
during which some factors of production
cannot be changed, even with the change in
the level of output.eg land
On the other hand some factors vary with the
variations in the level of output these factors
are called variable factors.e.g raw material ,labour
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Types of Costs
Variable Costs
These costs exist only if production occurs.
E.g., fuel for tractor, seed, etc.
Rises when production rises and vice versa.
Also known as prime costs.
Fixed Costs
These cost exist whether production occurs or not.
In the long-run there are no fixed costs.
Can be both cash and non-cash expenses.
E.g., depreciation on tractors and buildings, rent on land etc.
Also known as overhead costs.
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Which costs are variable and which are fixed depends on thetime horizon
Short time horizonmost costs are fixed
Long time horizonmany costs become variable
In determining how changes in production will affect costs, wemust consider if it affects fixed or variable costs
Fixed and variable cost
Total cost
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Total cost.
Some costs vary with output, while some remain the same ,no matter amount ofoutput.
Fixed Cost(FC)cost that does not vary with the level of output.- have to be paid as long as the firm stays in business (even if output is zero)
Variable Cost(VC)cost that varies as the level of output varies.
Total Cost(TC or C)total economic cost of production, consisting of fixed andvariable costs.
TC=FC+VC
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Difference betweenTFC
and TVCTFC
The fixed cost are contractually
fixed. Thus , even if the output
is zero , the firm has to bearthese cos
TFC does not depend on the
level of output. It remain fixed.
TFC does not exist in the longrun.
TFC curve become horizontal.
TVC
The variable cost are
contractually fixed. Thus ,
when the output is zero ,the TVC also become zero.
TVC depends on the level of
output.
TVC exist both during shortrun and long run.
TVC curve takes the shape
of inverted S
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Cost Curves for a Firm
Output
Cost($ peryear)
100
200
300
400
0 1 2 3 4 5 6 7 8 9 10 11 12 13
TVC
Variable costincreases withproduction and
the rate varies withincreasing &
decreasing returns.
TC
Total costis the vertical
sum of FCand VC.
TFC50
Fixed cost does notvary with output
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Shifts of the Cost Curves
Changes in resource prices or technology will cause costs to
change
Cost curves shift
FC increases by 100
Shift of FC curve
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Shift of FC curve
Output
Cost($ peryear)
100
200
300
400
0 1 2 3 4 5 6 7 8 9 10 11 12 13
VC
TC
FC50
FC150
TC
Total costs for firm X
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Output(Q)
0
12345
67
TFC
(Rs.)
12
1212121212
1212
Total costs for firm X
Total costs for firm X
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TFC
Output(Q)
0
12345
67
TFC
(Rs.)
12
1212121212
1212
Total costs for firm X
Total costs for firm X
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TFC
Output(Q)
0
12345
67
TFC
(Rs.)
12
1212121212
1212
TVC
(Rs.)
0
1016212840
6091
Total costs for firm X
Total costs for firm X
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TVC
Output(Q)
0
12345
67
TFC
(Rs.)
12
1212121212
1212
TVC
(Rs.)
0
1016212840
6091
TFC
Total costs for firm X
Total costs for firm X
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TVC
TFC
Diminishing marginalreturns set in here
Total costs for firm X
Total costs for firm X
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TVC
Output(Q)
0
12345
67
TFC
(Rs.)
12
1212121212
1212
TVC
(Rs.)
0
1016212840
6091
TFC
Total costs for firm X
Total costs for firm X
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TVC
TFC
Output(Q)
0
12345
67
TFC
(Rs.)
12
1212121212
1212
TVC
(Rs.)
0
1016212840
6091
TC
(Rs.)
12
2228334052
72103
Total costs for firm X
Total costs for firm X
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TC
Output(Q)
0
12345
67
TFC
(Rs.)
12
1212121212
1212
TVC
(Rs.)
0
1016212840
6091
TC
(Rs.)
12
2228334052
72103
TVC
TFC
Total costs for firm X
Total costs for firm X
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TC
TVC
TFC
Diminishing marginalreturns set in here
Total costs for firm X
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46
Recap of TC
Total Fixed Costs (TFC)
The summation of all fixed and sunk costs to production.
Total Variable Costs (TVC)
The summation of all variable costs to production.
Total Costs (TC)
The summation of total fixed and total variable costs.
TC=TFC+TVC
Average Costs
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Average Costs
Average Total costfirms total cost divided by its level of output (average cost per unitof output)
ATC=AC=TC/Q
Average Fixed costfixed cost divided by level of output (fixed cost per unit of output)
AFC=FC/Q
Average variable costvariable cost divided by the level of output.
AVC=VC/Q
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Average Cost
Average Fixed Costs (AFC)
The total fixed costs divided by output.
Average Variable Costs (AVC)
The total variable costs divided by output.
Average Total Costs (ATC)
The total costs divided by output.
The summation of average fixed costs and average variable
costs, i.e., ATC=AFC+AVC.
Summary
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Summary
In the short run, the total cost of any level of output is the sumof fixed and variable costs: TC=FC+VC
Average fixed (AFC), average variable (AVC), and average totalcosts,(ATC) are fixed, variable, and total costs per unit of output;marginalcost is the extra cost of producing 1 more unit of output.
AFC is decreasing
AVC and ATC are U-shaped, reflecting increasing and thendiminishing return
Marginal cost curve (MC) falls and then rises, intersectingboth AVC and ATC at their minimum points.
Marginal Cost change (increase) in cost resulting from the production of
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Marginal Cost change (increase) in cost resulting from the production ofone extra unit of output
Denote - change. For example TC - change in total cost
MC=TC/Q
Example: when 4 units of output are produced, the cost is 80, when 5 units areproduced, the cost is 90. MC=(90-80)/1=10
MC=TVC/Q
since TC=(TFC+TVC) and TFC does not change with Q
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MarginalCost
Marginal Costs
The change in total costs divided by the change in
output.
TC/Y
The change in total variable costs divided by the
change in output.
TVC/Y
Deriving marginal costsCosts (Rs )
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g g
Q TC MC0 12
1 222 283 334 405 526 72
7 103
10657
1220
31
Q
Costs (Rs.)
Deriving marginal costsCosts (Rs.)
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TC
g g
Q TC MC0 12
1 222 283 334 405 526 72
7 103
10657
1220
31
Q
Costs (Rs.)
Costs (Rs.)
Deriving marginal costs
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Q TC MC0 12
1 222 283 334 405 526 72
7 103
10657
1220
31
TC
TC= 12
Q = 1
Q
Costs (Rs.) g g
Costs (Rs.)
Deriving marginal costs
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TC
MCDiminishingreturns set
in here
Q
Costs (Rs.) g g
Q TC MC0 12
1 222 283 334 405 526 72
7 103
10657
1220
31
Costs (Rs.)
Deriving marginal costs
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MC
Q
Costs (Rs.) g g
Diminishing marginalreturns set in here
A Firms Short Run Costs
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C t C
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Cost Curves
0
20
40
60
80
100
120
0 12
Output (units/yr)
Cost
($/unit)
MC
ATC
AVC
AFC
Marginal Product and Costs
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Marginal Product and Costs
Suppose a firm pays each worker $50 a day.
Units of
Labor
Total
Product
MP VC MC
0 0 0 0
1 10 10 50 5
2 25 15 100 3.33
3 45 20 150 2.5
4 60 15 200 3.33
5 70 10 250 5
6 75 5 300 10
Short-run Costs and Marginal Product
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Short run Costs and Marginal Product
production with one input Llabor; (capital is fixed)
Assume the wage rate (w) is fixed
Variable costs is the per unit cost of extra labor times the amount of extra labor:VC=wL
D Denote - change. For example VC is change in variable cost.
MC=VC/Q ; MC =w/MPL,
where MPL=Q/L
With diminishing marginal returns: marginal cost increases as output increases.
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Short-Run Cost Functions
Total Cost = TC = f(Q)
Total Fixed Cost = TFC
Total Variable Cost = TVC
TC = TFC + TVC
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Short-Run Cost Functions
Average Total Cost = ATC = TC/Q
Average Fixed Cost = AFC = TFC/Q
Average Variable Cost = AVC = TVC/Q
ATC = AFC + AVC
Marginal Cost = TC/Q = TVC/Q
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Short-Run Cost Functions
Q TFC TVC TC AFC AVC ATC MC
0 $60 $0 $60 - - - -
1 60 20 80 $60 $20 $80 $20
2 60 30 90 30 15 45 10
3 60 45 105 20 15 35 15
4 60 80 140 15 20 35 35
5 60 135 195 12 27 39 55
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Relation between average and
marginal costAverage cost
=TC/ QMarginal cost= tc n- tc n-1
Costs (Rs.)
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Q
Q TVC AVCCosts (Rs.)
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0 0 -1 10 102 16 83 21 7
4 28 75 40 86 60 107 91 13
Q
AFC
Q TVC AVCCosts (Rs.)
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3
0 0 -1 10 102 16 83 21 7
4 28 75 40 86 60 107 91 13
Q
AFC
AVC
Q TC ACCosts (Rs.)
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0 121 22 222 28 143 33 11
4 40 105 52 10.46 72 127 103 14.7
Q
AFC
AVC
Q TC ACCosts (Rs.)
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0 121 22 222 28 143 33 11
4 40 105 52 10.46 72 127 103 14.7
Q
AC
AFC
AVC
Q TC MC0 12
Costs (Rs.)
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0 121 222 283 33
4 405 526 727 103
1065
7122031
Q
Q TC MC0 12
Costs (Rs.)
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MC
0 121 222 283 33
4 405 526 727 103
1065
7122031
Q
Q TC MCAC0 12
Costs (Rs.)
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0 121 222 283 33
4 405 526 727 103
1065
7122031
MC-221411
1010.41214.7
Q
Q TC MCAC0 12
Costs (Rs.)
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0 121 222 283 33
4 405 526 727 103
1065
7122031
MC-221411
1010.41214.7
Q
AC
Average and marginal costs
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Output (Q)
Costs
(Rs.)
AFC
AVC
MC
x
AC
z
y
g g
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Long-run costs
Long-run costs
=TC / Q
curves
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curves
OutputO
C
osts
LRAC
Economies of Scale
Alternative long-run average cost
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OutputO
C
osts
LRAC
Diseconomies of Scale
g gcurves
curves
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OutputO
C
osts
LRAC
Constant costs
curves
A typical long-run average cost curve
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OutputO
C
osts
LRAC
A typical long-run average cost curve
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OutputO
C
osts
LRACEconomiesof scale
Constantcosts
Diseconomiesof scale
Long-run average and marginal costs
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OutputO
C
osts
LRACLRMC
Economies of Scale
Long-run average and marginal costs
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OutputO
C
osts
LRAC
LRMC
Diseconomies of Scale
Long-run average and marginal costs
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OutputO
C
osts
LRAC= LRMC
Constant costs
Long-run average and marginal costs
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OutputO
C
osts
LRMC
LRAC
Initial economies of scale,then diseconomies of scale
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Long-Run Cost Curves
Long-Run Total Cost = LTC = f(Q)
Long-Run Average Cost = LAC = LTC/Q
Long-Run Marginal Cost = LMC = LTC/Q
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Minimizing Costs Internationally
Foreign Sourcing of Inputs
New International Economies of Scale
Immigration of Skilled Labor
Brain Drain
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Long-run costs
Relationship between
short-run and long-runACcurves
Deriving long-run average cost curves: factories of fixed size
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SRAC3
Costs
OutputO
SRAC4
SRAC5
5 factories
4 factories3 factories2 factories
1 factory
SRAC1 SRAC2
Deriving long-run average cost curves: factories of fixed size
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SRAC1
SRAC3
SRAC2 SRAC4
SRAC5
LRAC
Costs
OutputO
Deriving long-run average cost curves: choice of factory size
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Costs
OutputO
Examples of short-runaverage cost curves
Deriving long-run average cost curves: choice of factory size
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LRAC
Costs
OutputO
Relationship Between Long-Run and
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Short-Run Average Cost Curves
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Opportunity costthe value of a highestforgone alternative;cost associated with opportunities that areforgone when a firms resources are not put to
their highest-value use.
Thus we shift some factors of production from one line of production to the other ,
then the amount of output forgone is known as the opportunity cost.
Opportunity Cost
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Opportunity Cost
Opportunity cost what you must give up whenyou make an economic choice.
Example:
I chose the popcorn, so I have to give up the pretzel. That ismy opportunity cost.
Opportunity Cost
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96 of 33
Opportunity Cost
Opportunity costis the best
alternative that we forgo, or
give up, when we make achoice or a decision.
Nearly all decisions involve
trade-offs.
OPPORTUNITY COST DEFINED
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Introduction slide 97
OPPORTUNITY COST DEFINED
The opportunity cost of doing something is whatyou must give up in order to do it.
The cost of a pizza is what you must give up to
consume it, which in this case is easily computed in
money. The cost of a college education includes both money
and other foregone alternatives. For example, the cost
of a year at MSU includes not only tuition and books,
but the income you could have earned working on afull time job.
The cost of attending a Lugnuts baseball game includes
the value of the time you could have spent studying
economics.
The PPC can show opportunity cost
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Introduction slide 98
The PPC can show opportunity cost
Suppose you are at some point on a PPC.
Then suppose you want to consume one more pizza.
The opportunity cost of one more pizza is the
amount of spaghetti you must give up in order to getit.
Note that this opportunity cost is equal to minus the
slope of the PPC.
PRODUCTION POSSIBILITY CURVE
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Introduction slide 99
PRODUCTION POSSIBILITY CURVE
SPAGHETTI
PIZZA
More pizza means less spaghetti
0
100200
300
400
0 10 20 30 40 50 60
OPPORTUNITY COST INCREASES AS
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Introduction slide 100
MORE OF A GOOD IS PRODUCED
Not only does more pizza mean less spaghetti,but each additional pizza costs more than the
one before it.
This idea shows up as the PPC being concave
to the origin. (The curve bows out.)
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Introduction slide 101
Opportunity cost of more pizza is
constant.
Production Possibility Curve
0
100
200300
400
0 10 20 30 40 50 60
SPAGHETTI
PIZZA
Marginal rate of transformation
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(MRT)
The loss in the output of Y for every additionalincrement in the output of X, is considered as
the marginal opportunity cost of X. this is
known as MRT. Marginal opp. Cost=y/ x
Where y= change in the output of Y
x= change in the output of X
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While measuring the MRT , WE CONSIDER THE ABSOLUTE VALUE OF Y/ X
I.E. IGNORING THE - OR + SIGN).THIS IS BECAUSE , WITH AN INCREASE IN MARGINAL COST THE VALUE OF
Y/ X SHOULD RISE
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PRODUCTIO
N OF X
PRODUCTIO
N OF Y
MARGINAL
OPPORTUNITY
COST OF X
0 150
10 140 140-150/10-0=1
20 120 120-140/20-10=2
30 90 90-120/30-20=3
40 50 50-90/40-30=4
50 0 0-50/50-40=5
Y
XO
A
B
C
D
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The ppc becomes concave to the origin due tosuch inceasing mrginal opportunity cost.
IF THE RESOURCE is equally efficient in the
production of both X and Y , then with everyadditional increment in the production of X,
the society always loses a given amount of Y. it
implies constant marginal opportunity cost ofX.
PPC become downward sloping straight line.
Application of opportunity cost
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Since opportunity cost is the cost of the alternative
opportunities foregone , the question of opportunity costsarises in almost every area of economic decision-making.
The concept of opportunity cost applied in the following
fields:-
Planning for national priorities
Making production decisions
Making consumption decisions
Determining the relative price of a commodity
Determining the relative factor price
Determining economic rent of any factors of production.
Opportunity and accounting cost
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Opportunity and accounting cost
Opportunity cost This is an implicit cost.
This shows the probable loss of
income.
This is considered as economiccost.
This is important for making
managerial decisions of a firm.
It shows the currentreplacement value.
The depreciated value of that
machine may not be zero on
the basis of opportunity cost.
Accounting cost This is an explicit cost .
This shows the actual costs of
production.
This is considered as historicalcost or past cost.
This is important for making
financial reports of the firm.
It shows the past value or thehistorical value of the inventories.
The depreciated value of that
machine may be zero on the
basis of accounting cost
Scale of production
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Scale of production
It means the size or volume of production inthe firm.
The actual size of production of a firm is
determined by technological as well as marketforces.
Concept of indivisibility
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Concept of indivisibility
Some factors of production are indivisible i.e.they cannot be used in as small doses as we
like. They come in chunks. Eg.for a farmer the
bullock is indivisible factor because when thefarmer decide to reduce production by half
the bullock cannot be halved.
Economies of scale
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Economies of scale
When the scale of production expands , theproducers reap some benefits . These benefits
reduce their average cost of production .
These are called economies of scale.
Types of economies
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Types of economies
Internal Economies:- the economies enjoyedby a particular firm as a result of expansion of
its own output are called internal economies.
External economies:- when the output of afirm increases the other firms in the industry
also get some advantages. These are called
external economies of scale from the viewpoint of any of the other firm.