Chapter 9. Businesses and the Cost of Production

Chapter 9Businesses and the Cost of ProductionCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Economic CostsThe payment that must be made to obtain and retain the services of a resourceExplicit costsMonetary outlayImplicit costsOpportunity cost of using self-owned resourcesValue of next-best useIncludes a normal profitLO1Accounting Profit and Normal ProfitAccounting profit = Total revenue – explicit costsEconomic profit = Accounting profit – implicit costsEconomic profit (to summarize) = Revenue – economic cost = Revenue – explicit costs – implicit costsLO1Short Run and Long RunShort runSome variable inputsFixed plantLong runAll inputs are variableFirms can adjust plant size as well as enter and exit industryLO2Short Run Production RelationshipsTotal product (TP)Marginal product (MP)Average product (AP)LO2Marginal product change in total product change in labor input=Average producttotal product units of labor=Law of Diminishing ReturnsLaw of diminishing returnsResources are of equal qualityTechnology is fixedVariable resources are added to fixed resourcesAt some point, marginal product will fallRationaleLO2Short Run Production CostsFixed costs (TFC)Costs that do not vary with outputVariable costs (TVC)Costs that do vary with outputTotal cost (TC)Sum of TFC and TVCTC = TFC + TVCLO3Per-Unit, or Average, CostsAverage fixed cost AFC = TFC/QAverage variable cost AVC = TVC/QAverage total cost ATC = TC/QMarginal cost MC = ΔTC/ΔQLO3Long Run Production CostsThe firm can change all input amounts, including plant sizeAll costs are variable in the long runLong run ATCDifferent short run ATCsLO4Economies of ScaleEconomies of scaleLabor specializationManagerial specializationEfficient capitalOther factorsConstant returns to scaleLO4Diseconomies of ScaleDiseconomies of scaleControl and coordination problemsCommunication problemsWorker alienationShirkingLO4MES and Industry StructureMinimum efficient scale (MES)Lowest level of output at which long run average costs are minimizedCan determine the structure of the industryNatural monopolyLong run costs are minimized when one firm produces the productLO4