production and costs. economic versus accounting costs economic costs are theoretical constructs...
DESCRIPTION
Profit = Total Revenue – Total Costs Total Net Benefits = Total Benefits minus Total Costs Costs as Opportunity Costs –Explicit Costs –Implicit Costs Opportunity cost of entrepreneur’s invested capital Opportunity cost of entrepreneur’s time Economic versus Accounting ProfitTRANSCRIPT
Production and Costs
Economic versus Accounting Costs
• Economic costs are theoretical constructs which are intended to aid in rational decision-making.
• Accounting costs are legal constructs intended to provide uniformity in measurement.
• Profit = Total Revenue – Total Costs• Total Net Benefits = Total Benefits minus Total
Costs• Costs as Opportunity Costs
– Explicit Costs– Implicit Costs
• Opportunity cost of entrepreneur’s invested capital• Opportunity cost of entrepreneur’s time
• Economic versus Accounting Profit
Figure 1 Economic versus Accountants
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Revenue
Totalopportunitycosts
How an EconomistViews a Firm
How an AccountantViews a Firm
Revenue
Economicprofit
Implicitcosts
Explicitcosts
Explicitcosts
Accountingprofit
Production and Costs
• Technology is the state of knowledge about how to combine inputs to produce output.
• Production Function describes the relationship between inputs and outputs– Q = F ( K, L , NR, E)
• Short-run versus Long-run– SR - at least one input is fixed – limits to adjustment– LR – all inputs are variable – complete flexibility
A Short-Run Production Function and Costs
• Remember the widget example!• Assume two inputs, capital (say a factory)
and labor, and that capital is fixed in the short-run.
• Marginal Product of Labor – change in total output from added one more laborer.
• MPL = change in Q / change in L
Table 1 A Production Function and Total Cost: Hungry Helen’s Cookie Factory
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Figure 2 Hungry Helen’s Production Function
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Quantity ofOutput
(cookiesper hour)
150
140
130
120
110
100
90
80
70
60
50
40
30
20
10
Number of Workers Hired0 1 2 3 4 5
Production function
Different Measures of Cost
• Total Cost (TC) = FC+VC– Fixed Cost (FC) – are costs that do not vary with output.
FC only are present in the short-run are the result of fixed factors.
– Variable Cost (VC) – are costs that vary with output. VC result from different levels of fixed factors. All costs are VC in the long-run.
• Marginal Cost (MC) = change in TC/ change in Q and measures the cost of producing another unit.
• Average Cost (AC) = TC/Q and measures the cost of a typical unit of output.
Cost Formulas
• TC = FC +VC• Dividing both sides of the total cost formula
by Q, we get the average cost formula:– TC/Q = FC/Q + VC/Q– ATC = AFC +AVC– Average Total Cost = Average Fixed Cost +
Average Variable Cost
Marginal and Average Costs Revisted
• As Q increases if– MC<AC AC is falling– MC>AC AC is rising– So, when MC=AC AC is at its minimum
• The above also applies to MC and AVC• The height example
The Cost Curves• Short-run Cost Curves – at least one fixed factor, so
fixed costs exist. Economist like to use the example of the factory or plant size being fixed and labor being the variable input.– Law of Diminishing Marginal Returns implies that the MC
will eventually increase.– Increasing MC results in U-shaped ATC curves.– If MC initially falls and then begins to rise, both the ATC and
AVC curves will be U-shaped.– Since capital is often assumed to be fixed, the short-run cost
curves describe costs associated with the utilization of existing plant capacity.
Figure 5 Thirsty Thelma’s Average-Cost and Marginal-Cost Curves
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Costs
$3.50
3.25
3.00
2.75
2.50
2.25
2.00
1.75
1.50
1.25
1.00
0.75
0.50
0.25
Quantityof Output
(glasses of lemonade per hour)
0 1 432 765 98 10
MC
ATC
AVC
AFC
• Long-run cost curves – all factors are variable, so there are no fixed costs and all costs are variable.– Economies and diseconomies of scale
• benefits to a larger scale of operations – specialization, purchasing volume
• costs of a larger scale of operation – coordination problems– LR cost curves are U-shaped if a production process is
characterized by first by economies of scale, and then diseconomies of scale.
– Since capital can be varied, the long-run cost curves describe the costs with changing the scale of operations (reducing or increasing plant size.
Figure 7 Average Total Cost in the Short and Long Run
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Quantity ofCars per Day
0
AverageTotalCost
1,200
$12,000
ATC in shortrun with
small factory
ATC in shortrun with
medium factory
ATC in shortrun with
large factory
ATC in long run
Figure 7 Average Total Cost in the Short and Long Run
Copyright © 2004 South-Western
Quantity ofCars per Day
0
AverageTotalCost
1,200
$12,000
1,000
10,000
Economiesof
scale
ATC in shortrun with
small factory
ATC in shortrun with
medium factory
ATC in shortrun with
large factory ATC in long run
Diseconomiesof
scale
Constantreturns to
scale
Summary
• Short-run – at least one input is fixed so the primary decision is how best to use existing plant capacity
• Long-run – all inputs are variable so the primary decision is what overall scale of operations or plant size should be chosen.