Monday, October 6, 2008

Chapter 22

Chapter 22 – The Costs of Production

Economic Costs

The Economic/Opportunity cost of an object is the value or worth of the resources as produced in their best alternative use

Explicit and Implicit Costs

From a firms standpoint these are the payments a firm must make or incomes it must provide to attract the resources it needs away from alternative production opportunities

                Explicit Costs – monetary payments for resources

                Implicit costs – opportunity costs of using its self-owned, self-employed resources

Normal Profit as a (implicit) cost – You forgo other applications of your entrepreneurial talent

Economic Profit or Pure Profit

Economic profit is total revenue less any economic costs (Explicit, Implicit, Normal)

Short Run Production Relationships – since plant size is fixed, we will be focusing on labor-output relationship

Total Product (TP) – total quantity or total output of a particular good produced

Marginal Product (MP) – extra output or added product associated with adding a unit of a variable resource to the production process

Average Product (AP) – total products/units of labor

Law of diminishing returns – at a certain point, the amount you get out will start decreasing relative to the amount you put in

Short Run Production Costs

Fixed Costs – don’t depend on quantity produced, ie rent

Variable Costs – Change with the level of output, ie labor, fuel, etc

Total Cost – Sum of fixed and variable costs

Per-Unit or average costs

AFC – average fixed cost is found by dividing total fixed costs by quantity

AVC  - average variable cost is total variable cost divided by quantity (declines initially, has a minimum where it is most efficient, then increases)

ATC – Average total cost is the Total Cost/quantity

Marginal Cost – the cost of producing the last item, also the cost saved by not producing one more, Firm decides whether or not to produce more

Relation of MC to AVC to ATC

MC curve intersects AVC and ATC curves at their minimum points

When the marginal cost per unit is less than average, ATC will fall

As long as MC lies below ATC, ATC will fall and when it is above ATC will increase, thus it intersects at the lowest point

Shifts of the Cost Curves

At each level of output, AFC is greater (and thus ATC would increase)

A change in labor/resource costs would affect ATC and AVC

Long-Run Production Costs

Firm Size and Costs – at first it will cost ATC to decrease (greater efficiency) but eventually it will cause ATC to increase if there are too many plants

Cost Curve – At certain intervals of quantity the firm should increase production capabilities

Economies and diseconomies of scale – Law of diminishing returns does not apply in the long run, (diminishing returns assumes one resource is fixed), assume long-run ATC curve is U shaped

Economies of Scale – As plant size increases, a number of factors will for a time lead to a lower average costs of production

Labor specialization – more efficient

Managerial Specialization - Managers should be overseeing as many people as they can

Efficient Capital – many of the most efficient machines are too large and expensive to afford on the small scale

Diseconomies of Scale

The difficulty of managing and controlling a firms operations as it becomes a large-scale producer

More Red Tape

Constant Returns to Scale -  a period between economy of scale and diseconomy of scale where regardless of the scale, the ATC is the same

Minimum Efficient Scale and Industry Structure – MES – lowest level of output at which a firm can minimize long-run average costs

Given consumer demand, efficient production will be achieved with a few large-scale producers

When economies of scale are few and diseconomies come into play quickly, the minimum efficient scale occurs at a lower level of output

When economies of scale extend beyond the market size, natural monopolies are formed

Preferred stock – get benefits before others, get better dividends

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