Ch 10 - econ 1000 ch 10 notes PDF

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Chapter 10 Output and Cost Econ1000 Economic Cost and Profit Frim: an institution that hire factors of production and organizes them to produce and sell goods and services  Goal is to maximize profit  If firm fails to maximize profit, it is either eliminated or taken over by another firm that seek...

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Chapter 10

Output and Cost

Econ1000

Economic Cost and Profit Frim: an institution that hire factors of production and organizes them to produce and sell goods and services  Goal is to maximize profit  If firm fails to maximize profit, it is either eliminated or taken over by another firm that seeks to maximize profit Accounting Profit  Accountants measures a firm’s profit to ensure that the firm pays the correct amount of tax and to show it investors how their funds are being used  Accountants use revenue Canada rules based on standards established by the profession Profit = total revenue – total cost Economic Accounting  Economists measure a firm’s profit to enable them to predict a firm’s decision and understand the firms behaviour Economic Profit = total revenue – total cost - Total cost = total opportunity cost Firms Opportunity cost of Production  the value of the best alternative use of the resources that a firm uses in production  sum of the cost of using resources 1. bought in the market 2. owned by the firm: firm is implicitly renting the capital from itself a. Implicit Rental Rate of Capital: depreciation (change in market value from the beginning to the end of the period), foregone interest (selling the building to make profit from interest) 3. supplied by the firms owner: entrepreneurial skills a. Normal Profit: the profit that an entrepreneur can expect to receive on average b. Owner might supply both entrepreneurship and labour c. Rerun to entrepreneurship is profit d. Supply labour but not take a wage

Example:

Chapter 10

Output and Cost

Econ1000

Decision Time Frames  Firm makes decisions to achieve its main objective: Profit Maximization  Some decisions are critical to the survival of the firm  Some decisions are irreversible (or very costly to reverse)  Others are easily reversed and are less critical to the survival of the form but still influence profit 1. Short Run  At least one of the production input is fixed (we cant control it)  Decisions are easily removed  Eg: Labour, raw materials, energy 2. Long Run  Nothing is fixed in the long run- all resources can be varied  Very costly to reverse Sunk Cost: a cost incurred by the form and cannot be changed - Whatever you paid in the past, even if it is worthless now - Irrelevant to the firms current decisions Short-Run Technology Constraint  Assuming that the capital is fixed, to increase output in the short run, a firm must increase the amount of labour employed 1. Total Product: the total output produced in a given period by a given quantity of labour 2. Marginal Product : the change in total product that results from a one unit increase the quantity of labour employed 3. Average Product: the total product divided by the quantity of labour employed

Chapter 10

Output and Cost

Econ1000

A firm’s product schedules - As the quantity of labour employed increases:  Total product increases.  Marginal product increases initially …but eventually decreases.  Average product decreases.

Product Curves  Shows how the firm’s total product, marginal product, and average product changes as the firm varies the quantity of labour employed

The total product curve shows how total product changes with the quantity of labour employed

Marginal Product Curve  shows the marginal product of labour curve and how the marginal product curve relates to the total product curve. -

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The height of each bar measures the marginal product of labour. For example, when labour increases from 2 to 3, total product increases from 10 to 13, so the marginal product of the third worker is 3 units of output.

Chapter 10

Output and Cost

Econ1000

Increasing Marginal Returns: marginal product of a worker exceeds the marginal product of the previous worker

Decreasing Marginal Returns: Eventually, the marginal product of a worker is less than the marginal product of the previous worker

Law of diminishing Returns: a firm uses more of a variable input with a given quantity of fized inputs, the marginal product of the variable input eventually diminishes

Average Product Curve: When marginal product exceeds average product, average product increases

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When marginal product is below average product, average product decreases. When marginal product equals average product, average product is at its maximum.

To produce more output in the short run, a firm must employ more labour, which means increase it costs.

Chapter 10

Output and Cost

Econ1000

Types of Curves: 1. Total Cost  Total Cost (TC): the cost of ALL resources needed  Total Fixed Cost (TFC): the cost of the firms fixed inputs. Fixed costs do not change with output  Total Variable Cost (TVC): the cost of the firms variable inputs. Variable costs change with output Total Cost = Total Fixed Cost + Total Variable Cost Example: -

Total fixed cost is the same at each output level. Total variable cost increases as output increases. Total cost, which is the sum of TFC and TVC also increases as output increases.

2. Marginal Cost : The increase in total cost that results from a one-unit increase in total product  Over the output range with increasing marginal returns, marginal costs falls as output increases  Over the output range with diminishing marginal returns, marginal cost rises as output increases 3. Average Cost: Measures can be derived from each of the total cost measures: o Average Fixed Cost: the total fixed cost per unit of output o Average Variable Cost: the total variable cost per unit of output o Average Total Cost: total cost per unit of output Average Total Cost = Average Fixed Cost + Average Variable Cost Technology  Technological change influences both the product curves and the cost curves  An increase in productivity shifts the product curves upward and the cost curves downward  If technological advance results in the firm using more capital and less labout, fixed costs increase and variable costs decrease

Chapter 10

Output and Cost

Econ1000

Prices of Factors of Production  An increase in the price of a factor of production increases costs and shifts the cost curves  An increase in a fixed cost shifts the total cost (TC) and average total cost (ATC) curves upward but does not shif the marginal cost (MC) curve  Increase in a variable cost shifts the total cost (TC), average total cost (ATC), and the marginal cost (MC) curves up Long Run Cost  In long run, all inputs are variable and all costs are variable. There are no fixed cost. More flexibility on what the cost will be The Production Function  Behaviour of long run cost depends on the firms production function  Relationship between max quantity attainable and the quantities of both capital and labour Example:

Marginal Product of capital: the increase in output resulting from a one-unit increase in the amount of capital employed, holding constant the amount of labour employed  A firms production function exhibits diminishing marginal returns to labour (for a given plant) as well as diminishing marginal returns to capital (for a quantity of labour)  For each plant, diminishing marginal product of labour creates a set of short run, U shaped costs curves for MC, ACV, and ATC Short Run and Long Run Cost  Average cost of producing a given output varies and depends on the firms plant  Larger the plant = greater the output at which ATC is at a minimum Example: a firm has 4 different plants: 1,2,3, or 4 knitting machines. Each plant has a short run ATC curve

Chapter 10

Output and Cost

Econ1000

Long run average cost curve is made up from the lowest ATC for each output level (lowest price of making 1) Long run average cost curve: relationship between the lowesr attainable average total cost and output when both the plant and labout are varied.  A planning curve that tells the firm the plant that minimizes the cost of producing a given output range  Once the firm has chosen its plant, the firm incurs the cost that corresponds to the ATC curve for the plant Example: Long run average cost curve

Chapter 10

Output and Cost

Econ1000

Economies and Diseconomies of Scale Economies of Scale: features of a firms technology that lead to falling long run average cost as output increases Diseconomies of Scale: features of a firms technology that lead to rising long run average cost as output increases Constant Returns to Scale: features of a firms technology that lead to constant long run average cost as output increases Example: Economies and diseconomies of scale

Minimum Efficient Scale  a firm experiences economies of scale up to some output level  beyond output level, it moves into constant returns to scale or diseconomies of scale Minimum efficient scale: the smallest quantity of output at which the long run average cost reaches its lowest level  if long run average cost curve is U-shaped, the minimum point identifies the minimun efficient scale output level...