Short Run and Long Run Costs Chapter 5 Pages 178- 191
Shortrunandlongruncosts
Jan 20, 2015
its use full to students of management
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Short Run and Long Run Costs
Chapter 5 Pages 178-191
What would you need to start a Panera? http://www.panerabread.com/about/franchise/
Short Run versus Long Run?
short run - a period of time where some inputs are fixed (capital = building, equipment, etc.)
long run - a period of time in which all inputs can be varied (no inputs are fixed)
Short Run Cost Function
Definition: A function that defines the minimum
possible cost of producing each output level when variable factors are employed in the cost-minimizing fashion
In this case, what is your total product/output (Q)? Number of Paninis (for simplicity assume
that Panera only produces a single product)
In general a firm uses capital, labor and materials to produce the product/output.
In Short Run, how does the number of Paninis produced change as you change the number of workers?
# of workers # of paninis
0 0
1 5
2 12
3 20
4 25
5 28
How does output change if you hire one more person? Depends on how many workers you
currently have. Output increase by 5 paninis when you hire the 1st worker, increases by 7 paninis when you hire the 2nd worker, …., and increases 3 paninis when you hire the 5th worker.
What happens to “productivity” as the first few employees are hired?
Specialize and marginal product increases.
Marginal Product is the change in total output attributable to the last unit of an input.
What would happen to “productivity” if you continued to hire more and more workers?
Marginal product would start to fall because some inputs are fixed in the short run
Law of diminishing marginal returns OR Law of diminishing marginal product
What costs would you have to pay even if you didn’t produce a single panini?
Fixed Costs, FC (or Total Fixed Costs, TFC)
(often involves building and equipment)
Fixed Costs = Costs that do not change with changes in output
What costs would you have to pay only if you produced paninis?
Variable Costs, VC (or Total Variable Costs, TVC)
(often assumed to be labor and material)
Variable Costs = Costs that change with changes in output
What costs would increase if we wanted to produce one more panini?Variable Costs (such as labor
and materials)
If you hired more and more employees and the store became more and more
crowded until the marginal product of a worker started to fall, what would happen to the cost of producing one more panini (marginal cost)?
Marginal cost = cost of producing an additional unit of output
CostsQ FC VC TC AFC AVC ATC MC
0 100 0 100 - - - 50
1 100 50 150 100 50 150
30
2 100 80 180 50 40 90
20
3 100 100 200 33.3 33.33 66.7
10
4 100 110 210 25 27.5 52.5
20
5 100 130 230 20 26 46
Costs Q FC VC TC AFC AVC ATC MC
5 100 130 230 20 26 46
30
6 100 160 260 16.7 26.67 43.3
40
7 100 200 300 14.3 28.57 42.9
50
8 100 250 350 12.5 31.25 43.8
60
9 100 310 410 11.1 34.44 45.6
70
10 100 380 480 10 38 48
Q AFC AVC ATC MC 0 - - - 50
1 100.00 50.00 150.00 30
2 50.00 40.00 90.00 20
3 33.33 33.33 66.67 10
4 25.00 27.50 52.50 20
5 20.00 26.00 46.00 30
6 16.67 26.67 43.33 40
7 14.29 28.57 42.86 50
8 12.50 31.25 43.75 60
9 11.11 34.44 45.56 70
10 10.00 38.00 48.00
0
10
20
30
40
50
60
70
80
90
100
0 1 2 3 4 5 6 7 8 9 10
Q
$/Q
MC
ATC
AVC
AFC
What is happening to TC as Q increases? TC= ATC*Q
150180
480
Increases!
Q AFC AVC ATC MC0 - - -
501 100.00 50.00 150.00
302 50.00 40.00 90.00
203 33.33 33.33 66.67
104 25.00 27.50 52.50
205 20.00 26.00 46.00
306 16.67 26.67 43.33
407 14.29 28.57 42.86
508 12.50 31.25 43.75
609 11.11 34.44 45.56
7010 10.00 38.00 48.00
0
10
20
30
40
50
60
70
80
90
100
0 1 2 3 4 5 6 7 8 9 10
Q
$/Q
MC
ATC
AVC
AFC
What are total fixed costs in this example? AFC*Q
100*1=100
Q AFC AVC ATC MC0 - - -
501 100.00 50.00 150.00
302 50.00 40.00 90.00
203 33.33 33.33 66.67
104 25.00 27.50 52.50
205 20.00 26.00 46.00
306 16.67 26.67 43.33
407 14.29 28.57 42.86
508 12.50 31.25 43.75
609 11.11 34.44 45.56
7010 10.00 38.00 48.00
0
10
20
30
40
50
60
70
80
90
100
0 1 2 3 4 5 6 7 8 9 10
Q
$/Q
MC
ATC
AVC
AFC
Why are AFC diminishing? Spreading a fixed number out over a larger and larger Q
Q AFC AVC ATC MC0 - - -
501 100.00 50.00 150.00
302 50.00 40.00 90.00
203 33.33 33.33 66.67
104 25.00 27.50 52.50
205 20.00 26.00 46.00
306 16.67 26.67 43.33
407 14.29 28.57 42.86
508 12.50 31.25 43.75
609 11.11 34.44 45.56
7010 10.00 38.00 48.00
0
10
20
30
40
50
60
70
80
90
100
0 1 2 3 4 5 6 7 8 9 10
Q
$/Q
MC
ATC
AVC
AFC
Why is AVC getting closer to ATC?
Because ATC = AVC+AFCand AFC is getting close to 0
Q AFC AVC ATC MC0 - - -
501 100.00 50.00 150.00
302 50.00 40.00 90.00
203 33.33 33.33 66.67
104 25.00 27.50 52.50
205 20.00 26.00 46.00
306 16.67 26.67 43.33
407 14.29 28.57 42.86
508 12.50 31.25 43.75
609 11.11 34.44 45.56
7010 10.00 38.00 48.00
0
10
20
30
40
50
60
70
80
90
100
0 1 2 3 4 5 6 7 8 9 10
Q
$/Q
MC
ATC
AVC
AFC
Where does the law of diminishing marginal product set in and how do you know? Between Q = 4 and Q = 5
MC start increasing!
Why does this happen?An input is fixed in the short run!
Where does MC cross ATC?Where does MC cross AVC?
0
10
20
30
40
50
60
70
80
90
1000 1 2 3 4 5 6 7 8 9 10
Q
$/Q
MC
ATC
AVC
AFC
At their minimums
What is the relationship between MC and ATC? MC and AVC?
If MC<ATC, ATC is decreasingIf MC>ATC, ATC is increasingSame for AVC
Q AFC AVC ATC MC0 - - -
501 100.00 50.00 150.00
302 50.00 40.00 90.00
203 33.33 33.33 66.67
104 25.00 27.50 52.50
205 20.00 26.00 46.00
306 16.67 26.67 43.33
407 14.29 28.57 42.86
508 12.50 31.25 43.75
609 11.11 34.44 45.56
7010 10.00 38.00 48.00
0
10
20
30
40
50
60
70
80
90
100
0 1 2 3 4 5 6 7 8 9 10
Q
$/Q
MC
ATC
AVC
AFC
How do you know this is the short run?
There are fixed costs
Fixed Cost versus Sunk CostFixed Cost = costs that do not change with changes in
outputSunk Cost= a cost that is forever lost after it has been paid
Does profit maximizing output depend on whether cost if fixed or sunk given that you produce paninis?
Does the decision whether to produce any paninis depend on whether cost is fixed or sunk?
Short Run versus Long Run?
short run - a period of time where some inputs are fixed (capital = building, equipment, etc.)
long run - a period of time in which all inputs can be varied (no inputs are fixed)
Returns to Scale in Long Run Production Is the increase in output proportional to the
increase in “inputs”? What is the marginal product of changing
ALL inputs?
Economies to Scale
Exist when long-run average costs decline as output is increased.
Example in other words: to double output, you don’t have to double costs
Example in other words: if you double costs, you more than double the output
Why does there exist Economies of Scale? Specialization in production - get more
productive if specialize Can spread some costs over everything
(ex: advertising, R&D, capital investments)
Can command quantity discounts from suppliers
Diseconomies of Scale
Exist when long-run average costs rise as output is increased.
Example in other words: to double output, you have to more than double costs
Example in other words: if you double costs, you cannot double the output
Why Diseconomies of Scale?
Monitoring Morale Ex:
Constant Returns to Scale
Exist when long-run average costs remain constant as output is increased.
Example in other words: to double output, you have to double costs
Specific Example: Each of the following represent SATC curves at 3 different factory sizes that are
fixed in the short run: Short Run -At least one input
is fixed. Typically assume capital is fixed and labor/material is variable.
• Why do the ATC curves have the U-shape?
Law of diminishing marginal returns to variable input
Long Run - Nothing is fixed. Each of the following
represents a short run SATC curve at different levels of capital (building, equipment)
0
5
10
15
20
25
0 1 2 3 4 5 6 7 8 9 10 11 12
Q
AT
C
Small FactoryMedium Factory
Large Factory
Specific Example: Each of the following represent SATC curves at 3 different factory sizes that are
fixed in the short run: Suppose we initially
have a small factory and we’re producing one unit of output. If we want to increase output in the short run, how do we have to do it?
add more variable inputs
In the long run, is that the only option?
No, build a bigger factory
0
5
10
15
20
25
0 1 2 3 4 5 6 7 8 9 10 11 12
Q
AT
C
Small FactoryMedium Factory
Large Factory
Specific Example: 3 possible factory sizes
The least expensive way to produce Q = 1 is with a ___________ factory.
The least expensive way to produce Q = 2 is with a ___________ factory.
The least expensive way to produce Q = 3 is with a ___________ factory.
The least expensive way to produce Q = 4 is with a ___________ factory.
The least expensive way to produce Q = 5 is with a ___________ factory.
The least expensive way to produce Q = 6 is with a ___________ factory.
0
5
10
15
20
25
0 1 2 3 4 5 6 7 8 9 10 11 12
Q
AT
C
Small FactoryMedium Factory
Large Factory
small
small
medium
medium
medium
large
large
In the long run, you can choose any size factory you want...what is the LATC curve?
0
5
10
15
20
25
0 1 2 3 4 5 6 7 8 9 10 11 12
Q
AT
C
Small FactoryMedium Factory
Large Factory
LATC = Minimum of the SATCs!
LATC ≤ SATC
Where do Economies of Scale exist?
LATC
0
5
10
15
20
25
0 1 2 3 4 5 6 7 8 9 10 11 12
Q
AT
C
Small FactoryMedium Factory
Large Factory
Economies of Scale
Where do Diseconomies of Scale exist?
LATC
0
5
10
15
20
25
0 1 2 3 4 5 6 7 8 9 10 11 12
Q
AT
C
Small FactoryMedium Factory
Large Factory
Diseconomies of Scale
General Example – many possible levels of fixed inputs
Q
ATC
If these are many SATC, what does the LATC look like?
LATC - minimum of SATC
Why does the LATC curve have the U-shape?
Economies of ScaleConstant Returns to Scale
Diseconomies of Scale
Minimum Efficient Scale - lowest average costs