Chapter 22 Supply: The Costs of Doing Business. Morita’s Cost Curve (Sony Corp.) Akio Morita, founder of Sony Corporation, drew this cost curve for transistor.

Chapter 22Chapter 22

Supply: The Costs of Supply: The Costs of Doing BusinessDoing Business

Morita’s Cost Curve (Sony Corp.)Morita’s Cost Curve (Sony Corp.)

Akio Morita, founder of Sony Corporation, drew this cost curve for transistor radios. He saw that per-unit costs would fall initially and then rise. He turned down an order for 100,000 units because he thought it would be risky to increase production levels that high. He asked “What if there were no repeat order the next year?”

Firms and ProductionFirms and ProductionReview from Chapter 4Review from Chapter 4

Recall that the terms Recall that the terms companycompany, , businessbusiness, and , and enterpriseenterprise are are used interchangeably with used interchangeably with firmfirm..

Firms can be Firms can be sole proprietorshipssole proprietorships, , partnershipspartnerships, or , or corporationscorporations.. They can be They can be nationalnational or or multinationalmultinational.. We use the term “firm” to refer to all types of business We use the term “firm” to refer to all types of business

organization.organization. A A public companypublic company has its shares traded on a stock exchange. A has its shares traded on a stock exchange. A

private companyprivate company does not have its ownership shares traded on does not have its ownership shares traded on an exchange. Nonetheless, we can refer to the an exchange. Nonetheless, we can refer to the ownersowners of a of a company whether the company is public or private.company whether the company is public or private.

Output and ResourcesOutput and Resources

Businesses pay households income for the use of Businesses pay households income for the use of resources in production—resources in production—wageswages for their labor, for their labor, rentrent for land, and for land, and interestinterest for capital. for capital.

Households buy goods and services with their Households buy goods and services with their income. The total payments received by businesses income. The total payments received by businesses form the firm’s form the firm’s total revenuetotal revenue..

The difference between the firm’s total revenue and The difference between the firm’s total revenue and the total payments for resources is the total payments for resources is profitprofit, which also , which also flows to households as income.flows to households as income.

The Circular FlowThe Circular Flow

Total Physical Product (TPP)Total Physical Product (TPP)

The The total physical producttotal physical product (TPP) curve or (TPP) curve or schedule schedule is the relationship between a variable is the relationship between a variable resource and output, for a given quantity of fixed resource and output, for a given quantity of fixed resource(s). Sometimes referred to as resource(s). Sometimes referred to as total total productproduct..

TPP is subject to the TPP is subject to the law of diminishing marginal law of diminishing marginal returnsreturns: when the amount of at least one of the : when the amount of at least one of the resources is fixed, successive increases in the resources is fixed, successive increases in the amount of a variable resource will eventually amount of a variable resource will eventually yield declining incremental increases in output.yield declining incremental increases in output.

APP and MPPAPP and MPP The law of diminishing marginal returns shows up more The law of diminishing marginal returns shows up more

clearly in the APP and MPP.clearly in the APP and MPP. The The average physical product (APP)average physical product (APP) is the (average) is the (average)

output per unit of resource.output per unit of resource.

The The marginal physical product (MPP)marginal physical product (MPP) is the amount of is the amount of additional output that is produced when one additional additional output that is produced when one additional unit of a resource is used in combination with the same unit of a resource is used in combination with the same amount of other resources.amount of other resources.

mechanics of numberoutput totalAPP

mechanics of number in changeoutput totalMPP

Total, Average, and Marginal ProductTotal, Average, and Marginal Product

MechanicsMechanics Total OutputTotal Output Average Average Physical Physical ProductProduct

Marginal Marginal Physical Physical ProductProduct

00 00 ---- ----

11 100100 100100 100100

22 250250 125125 150150

33 360360 120120 110110

44 440440 110110 8080

55 500500 100100 6060

66 540540 9090 4040

77 550550 78.678.6 1010

88 540540 675675 -10-10

Total, Average, Total, Average, and Marginal and Marginal

ProductProduct

Marginal and Average Marginal and Average Physical ProductPhysical Product

Marginals and averages always behave the same way. When the marginal is above the average, the average is rising. When the marginal is below the average, the average is falling. MPP=APP at the maximum of the APP.

Total CostsTotal Costs

The total cost (TC) schedule is plotted on a graph The total cost (TC) schedule is plotted on a graph with output measure on the horizontal axis and total with output measure on the horizontal axis and total cost on the vertical.cost on the vertical.

The total physical product (TPP) curve is plotted with The total physical product (TPP) curve is plotted with the units of variable resource on the horizontal axis the units of variable resource on the horizontal axis and total output on the vertical axis.and total output on the vertical axis.

The two curves have the same shape, but are mirror The two curves have the same shape, but are mirror images of one another. images of one another.

Both are shaped by diminishing marginal returns.Both are shaped by diminishing marginal returns.

Total CostsTotal Costs

Average CostsAverage Costs

Because the total cost and total physical Because the total cost and total physical product have the same shape, average product have the same shape, average physical product and average cost should physical product and average cost should also have the same shape.also have the same shape.

Average total cost (ATC)Average total cost (ATC) is the cost per unit is the cost per unit of output:of output:

output totalcost totalATC

Average CostsAverage Costs

Average CostsAverage Costs

Marginal CostsMarginal Costs

Marginal CostsMarginal Costs

Cost Schedules and Cost Cost Schedules and Cost CurvesCurves

Total fixed costs (TFC)Total fixed costs (TFC) are costs that must be paid are costs that must be paid whether the firm produces or not. TFC do not change whether the firm produces or not. TFC do not change with output.with output.

Total variable costs (TVC)Total variable costs (TVC) are the costs that rise or are the costs that rise or fall as production rises or falls.fall as production rises or falls.

Total costs (TC)Total costs (TC) are the sum of total variable and are the sum of total variable and total fixed coststotal fixed costs

Average total costAverage total cost is sometimes referred to as is sometimes referred to as short-short-run average total cost (SRATC)run average total cost (SRATC) because there are because there are only fixed resources and fixed costs in the short run. only fixed resources and fixed costs in the short run. Over the long run, all resources and costs can be Over the long run, all resources and costs can be changed.changed.

Marginal and Average CostsMarginal and Average Costs

(1)(1)

Total Total Output Output

(Q)(Q)

(2)(2)

Total Total Fixed Fixed Costs Costs (TFC)(TFC)

(3)(3)

Total Total Variable Variable

CostsCosts

(TVC)(TVC)

(4)(4)

Total Total CostsCosts

(TC)(TC)

(5)(5)

Average Average Fixed Fixed CostsCosts

(AFC)(AFC)

(6)(6)

Average Average Variable Variable

Costs Costs (AVC)(AVC)

(7)(7)

Average Average Total Total CostsCosts

(ATC)(ATC)

(8)(8)

Marginal Marginal CostsCosts

(MC)(MC)

00 $10$10 $ 0$ 0 $10$10

11 $10$10 $10$10 $20$20 $10$10 $10$10 $20$20 $10$10

22 $10$10 $18$18 $28$28 $5$5 $9$9 $14$14 $8$8

33 $10$10 $25$25 $35$35 $3.33$3.33 $8.33$8.33 $11.6$11.6 $7$7

44 $10$10 $30$30 $40$40 $2.5$2.5 $7.5$7.5 $10$10 $5$5

55 $10$10 $35$35 $45$45 $2$2 $7$7 $9$9 $5$5

66 $10$10 $42$42 $52$52 $1.66$1.66 $7$7 $8.66$8.66 $7$7

77 $10$10 $50.6$50.6 $60.6$60.6 $1.44$1.44 $7.2$7.2 $8.6$8.6 $8.6$8.6

88 $10$10 $60$60 $70$70 $1.25$1.25 $7.5$7.5 $8.75$8.75 $9.4$9.4

99 $10$10 $80$80 $90$90 $1.1$1.1 $8.8$8.8 $10$10 $20$20

A

B

Marginal and Average Cost Marginal and Average Cost CurvesCurves

Marginal and Average Cost Marginal and Average Cost CurvesCurves

Long-Run Cost CurvesLong-Run Cost Curves

When all resources are changed, we say that the When all resources are changed, we say that the scale of scale of the firmthe firm has changed. has changed.

In the short run, scale is fixed because at least one resource In the short run, scale is fixed because at least one resource cannot be changed.cannot be changed.

In the long run, the firm can choose In the long run, the firm can choose anyany of the SRATC of the SRATC curves.curves.

The lowest-cost combinations of resources with which The lowest-cost combinations of resources with which each level of output is produced when all resources are each level of output is produced when all resources are variable is called the variable is called the long-run average total cost (LRATC)long-run average total cost (LRATC)..

The long run is sometimes referred to as a The long run is sometimes referred to as a planning planning horizonhorizon because over the long run the firm has all options because over the long run the firm has all options open to it. open to it.

Short-Run and Short-Run and Long-Run Long-Run

Average-Cost Average-Cost CurvesCurves

Shape of LRATCShape of LRATC

The LRATC curve gets its shape from The LRATC curve gets its shape from economies and diseconomies of scale.economies and diseconomies of scale. If producing each unit of output becomes If producing each unit of output becomes less less

costlycostly as the amount of output increases, we say as the amount of output increases, we say there are there are economies of scaleeconomies of scale..

If producing each unit of output becomes If producing each unit of output becomes more more costlycostly as output rises, we say there are as output rises, we say there are diseconomies of scalediseconomies of scale..

If unit costs remain If unit costs remain constantconstant as output rises, we as output rises, we say there are say there are constant returns to scaleconstant returns to scale..

Long-Run and Long-Run and Short-Run Cost Curves (1)Short-Run Cost Curves (1)

Long-Run and Long-Run and Short-Run Cost Curves (2)Short-Run Cost Curves (2)

Minimum Efficient ScaleMinimum Efficient Scale

Most industries experience both economies Most industries experience both economies and diseconomies of scale.and diseconomies of scale.

If the long-run average total cost curve If the long-run average total cost curve reaches a minimum, the level of output at reaches a minimum, the level of output at which the minimum occurs is called the which the minimum occurs is called the minimum efficient scale (MES)minimum efficient scale (MES). . The MES varies considerably across industries.The MES varies considerably across industries.

Morita’s ProblemMorita’s Problemand Minimum Efficient Scaleand Minimum Efficient Scale