A firm’s actual cash payments for its inputs A firm’s actual cash payments for its inputs IMPLICIT COSTS IMPLICIT COSTS • Opportunity costs of non-purchased inputs Opportunity costs of non-purchased inputs such as the entrepreneur’s time and money. such as the entrepreneur’s time and money. – opportunity cost of something is what you opportunity cost of something is what you sacrifice to get it. sacrifice to get it. • Opportunity cost of the entrepreneur’s time: Opportunity cost of the entrepreneur’s time: Time given up to operate a firm; Time given up to operate a firm; • Opportunity cost of funds: Opportunity cost of funds: Money given up to set up and run a Money given up to set up and run a business. business. EXPLICIT COSTS EXPLICIT COSTS
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A firm’s actual cash payments for its inputs IMPLICIT COSTS Opportunity costs of non-purchased inputs such as the entrepreneur’s time and money.Opportunity.
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A firm’s actual cash payments for its inputsA firm’s actual cash payments for its inputs
IMPLICIT COSTSIMPLICIT COSTS• Opportunity costs of non-purchased inputs such as the Opportunity costs of non-purchased inputs such as the
entrepreneur’s time and money.entrepreneur’s time and money.– opportunity cost of something is what you sacrifice to opportunity cost of something is what you sacrifice to
get it.get it.• Opportunity cost of the entrepreneur’s time:Opportunity cost of the entrepreneur’s time:
Time given up to operate a firm;Time given up to operate a firm;• Opportunity cost of funds:Opportunity cost of funds:
Money given up to set up and run a business.Money given up to set up and run a business.
EXPLICIT COSTSEXPLICIT COSTS
Economic CostEconomic Cost
• The sum of explicit and The sum of explicit and implicit costs.implicit costs.
• The economic cost is higher The economic cost is higher because the economist because the economist includes implicit costs but includes implicit costs but the accountant does not.the accountant does not.
Accounting versus Economic CostAccounting versus Economic Cost
A period of time over which at least one input to production A period of time over which at least one input to production is fixed. For most firms, the fixed input is capital: firm is fixed. For most firms, the fixed input is capital: firm cannot modify production facility or build a new facility.cannot modify production facility or build a new facility.
• LONG RUNLONG RUN
A period of time over which a firm is perfectly flexible in its A period of time over which a firm is perfectly flexible in its choice of inputs.choice of inputs.
In the long run, a firm can build a new production facility In the long run, a firm can build a new production facility (factory,store, office or restaurant) or modify an existing (factory,store, office or restaurant) or modify an existing facility, hire a workforce, and buy raw materials. facility, hire a workforce, and buy raw materials.
TIME PERIODSTIME PERIODS
Time Period DecisionsTime Period Decisions
• Short RunShort Run
How much output to produce;How much output to produce;
• Long RunLong Run
What type of production facility What type of production facility to build;to build;
Principle of Diminishing Principle of Diminishing ReturnsReturns
• Suppose an output is produced with Suppose an output is produced with two or more inputs, and we increase two or more inputs, and we increase one input while holding the other one input while holding the other inputs fixed. Beyond some point -- inputs fixed. Beyond some point -- called the point of diminishing returns called the point of diminishing returns -- output will increase at a decreasing -- output will increase at a decreasing rate.rate.
Computer Chip ManufacturingComputer Chip Manufacturing• As firm packs more and more As firm packs more and more
workers into factory, total output workers into factory, total output increases, but at a decreasing rate.increases, but at a decreasing rate.
------------flipping this around-------------------------flipping this around-------------
• As the firm steadily increases its As the firm steadily increases its output, the firm requires more and output, the firm requires more and more workers to increase its output more workers to increase its output by a single chip.by a single chip.
Diminishing Returns and Increasing Marginal CostDiminishing Returns and Increasing Marginal Cost
For One More ChipFor One More ChipQuantity of Additional Additional Additional MarginalQuantity of Additional Additional Additional Marginal
ChipsChips Labor Time Labor Cost Material Cost Labor Time Labor Cost Material CostCostCost
The change in total cost The change in total cost resulting from a one-unit resulting from a one-unit increase in the output of increase in the output of an existing production an existing production facility.facility.
Short-Run Marginal and Average Cost Curves
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short-run average total cost curve (SATC)
short-run marginal cost curve (SMC)
MarginalorAverageCost$$$
Quantity of Chips produced per hour
QUANTITY SMC SATC 100 26 90 300 58 58 400 90 68
Short-Run Average Total Cost Short-Run Average Total Cost (SATC)(SATC)
• Equals the total cost divided by the Equals the total cost divided by the quantity of output, or the cost per quantity of output, or the cost per unit output.unit output.
• Total cost is the sum of the fixed Total cost is the sum of the fixed cost per chip, the labor cost per cost per chip, the labor cost per chip, and the material cost per chip.chip, and the material cost per chip.
• U-shaped.U-shaped.
Short-Run Average Total CostShort-Run Average Total Cost QUANTITY OF QUANTITY OF
CHIPSCHIPS SMALL MEDIUM SMALL MEDIUM
LARGE LARGE
Number of ChipsNumber of Chips 100 100 300 300 400400
• Short-run average total cost is at its Short-run average total cost is at its minimum value where average total minimum value where average total cost and marginal cost are equal. cost and marginal cost are equal. Average total cost slope = 0.Average total cost slope = 0.
• If marginal cost is less than average If marginal cost is less than average total cost, average total cost is total cost, average total cost is decreasing -- has a negative slope.decreasing -- has a negative slope.
• If marginal cost is greater than average If marginal cost is greater than average total cost, average total cost is total cost, average total cost is increasing -- has a positive slope.increasing -- has a positive slope.
Quantity of Chips per HourQuantity of Chips per Hour
SATC = SAVC + AFCSATC = SAVC + AFC
LONG-RUN AVERAGE COSTLONG-RUN AVERAGE COST• Total cost divided by the Total cost divided by the
quantity of output when the quantity of output when the firm can choose a production firm can choose a production facility of any sizefacility of any size
• The long-run average cost The long-run average cost curve is L-shaped, initially the curve is L-shaped, initially the result of economies of scale.result of economies of scale.
Economies of Scale Economies of Scale Cost saving associated with scaling up -- Cost saving associated with scaling up --
adding more capital, labor and materials to adding more capital, labor and materials to produce more output may be caused by produce more output may be caused by either of two effects:either of two effects:
• • Indivisible inputs;Indivisible inputs;
• • SpecializationSpecialization
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LONG-RUN AVERAGE COST CURVELONG-RUN AVERAGE COST CURVE FOR ALUMINUM PRODUCTION FOR ALUMINUM PRODUCTION
Long-run average cost curveLong-run average cost curve
Average costAverage cost$ per pound$ per pound
Millions of Pounds of Aluminum per yearMillions of Pounds of Aluminum per year
Indivisible InputsIndivisible Inputs Inputs which cannot be scaled down to Inputs which cannot be scaled down to
produce a small quantity of output. produce a small quantity of output. Examples:Examples:
• Railroad track between two cities cannot be Railroad track between two cities cannot be scaled from two to one track.scaled from two to one track.
• An industrial mold must be complete to An industrial mold must be complete to produce many copies or a single copy.produce many copies or a single copy.
SpecializationSpecialization• In a small operation with just a few workers, In a small operation with just a few workers,
each performs a wide variety of tasks.each performs a wide variety of tasks.
• In a large operation with many workers, In a large operation with many workers, each worker specializes in one or two tasks, each worker specializes in one or two tasks, and is more productive because:and is more productive because:
British Sulfuric Acid British Sulfuric Acid 1 million tons1 million tons
British Steel British Steel 9 million tons9 million tons
U.S. AutomobilesU.S. Automobiles 200,000 to 400,000 per year 200,000 to 400,000 per year
Large U.S. BreweriesLarge U.S. Breweries 4.5 million barrels 4.5 million barrels
DISECONOMIES OF SCALEDISECONOMIES OF SCALE
• Increase in output leads to increases Increase in output leads to increases in the average cost of production: in the average cost of production: higher costs accompany scaling up.higher costs accompany scaling up.
• Diseconomies may occur for two Diseconomies may occur for two reasons:reasons:
• Large organizations require several Large organizations require several layers of management (a layers of management (a bureaucracy) to coordinate the bureaucracy) to coordinate the activities of the different parts of the activities of the different parts of the organization. This leads to a organization. This leads to a positively sloped average-cost positively sloped average-cost curve.curve.
Increasing Input CostsIncreasing Input Costs
• As a firm increases its output, it will As a firm increases its output, it will demand more of each of its inputs, demand more of each of its inputs, which may lead to higher prices for which may lead to higher prices for some inputs. some inputs.
• Higher prices increases the average Higher prices increases the average cost of production, resulting in a cost of production, resulting in a positively sloped average-cost curve.positively sloped average-cost curve.
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS• Perfect Competition Perfect Competition ------
A market with a very large number of A market with a very large number of firms, each of which produces the firms, each of which produces the same standardized product and same standardized product and takes the market price as given.takes the market price as given.
A price-taking firm.A price-taking firm.
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS
• Perfect CompetitionPerfect Competition
EXAMPLESEXAMPLES
• • The wheat farmer,The wheat farmer,
• • The average stock investorThe average stock investor
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS• Monopolistic Competition Monopolistic Competition ------
There are many firms, each sells a There are many firms, each sells a differentiated product. Because products differentiated product. Because products sold by different firms are not perfect sold by different firms are not perfect substitutes, each firm has some control substitutes, each firm has some control over price. There are no barriers to over price. There are no barriers to entering the market. entering the market.
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS• Monopolistic competition Monopolistic competition ------
EXAMPLESEXAMPLES
• • restaurants,restaurants,
• • retail stores,retail stores,
• • gas stations,gas stations,
• • clothingclothing
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS• Oligopoly --- There are just a few Oligopoly --- There are just a few
firms in the market, a result of two firms in the market, a result of two sorts of barriers to entry:sorts of barriers to entry:
• • economies of scale,economies of scale,
• • government may limit number government may limit number of firms in the marketof firms in the market
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS• OligopolyOligopoly
EXAMPLESEXAMPLES
• • automobiles,automobiles,
• • airline travel,airline travel,
• • breakfast cerealsbreakfast cereals
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS• MonopolyMonopoly --- ---
A single firm serves the entire market. A single firm serves the entire market. A monopoly occurs when the A monopoly occurs when the barriers to entry are very strong, barriers to entry are very strong, which could result from very large which could result from very large economies of scale or a government economies of scale or a government limit on the number of firms.limit on the number of firms.
FOUR TYPES OF MARKETSFOUR TYPES OF MARKETS• MonopolyMonopoly --- ---
• • electric power generation,electric power generation,
established by government policyestablished by government policy::
• • drugs covered by patents,drugs covered by patents,
• • concessions in National Parksconcessions in National Parks
Characteristics of Different Types of MarketsCharacteristics of Different Types of Markets Perfect Perfect MonopolisticMonopolistic OligopolyOligopoly MonopolyMonopoly Competition Competition
CompetitionCompetition
NumberNumber very large very large many many few few one one
of firmsType of standardized differentiated std or diff. uniqueproductControl none slight considerable considerableover price if not
regulatedEntry no barriers no barriers large largeconditions barriers barriersExamples wheat restaurants automobiles local phone soybeans retail stores air travel and electric
clothing breakfast patentedcereal drugs
TOTAL REVENUETOTAL REVENUE
• The money the firm gets from selling its The money the firm gets from selling its product and is equal to price times quantity product and is equal to price times quantity sold:sold:
Total Revenue = price Total Revenue = price ** quantity quantity
ECONOMIC PROFITECONOMIC PROFIT
Total revenue - total economic costTotal revenue - total economic cost Total economic cost Total economic cost
= explicit costs= explicit costs
( firm’s actual cash payments for inputs ) ( firm’s actual cash payments for inputs )
+ implicit costs + implicit costs
( opportunity costs of non-purchased inputs, ( opportunity costs of non-purchased inputs, such as such as entrepreneur’s time or money )entrepreneur’s time or money )