Chapter 6: Businesses and Their Costs

Chapter 6Businesses and Their CostsMcGraw-Hill/IrwinCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reservedThe Business PopulationPlantFactory, farm, mine, store, website, warehouseFirmOperates one or more plantsIndustryGroup of firms that produce the same products6-*Corporation AdvantagesStocksOwnership shares of a corporationBondsLiabilities of a corporationLimited liabilityLO16-*Principal-Agent ProblemPrincipalsStockholdersAgentsExecutivesLO16-*Economic CostsThe payment that must be made to obtain and retain the services of a resourceExplicit costsMonetary paymentsImplicit costsValue of next best useSelf-owned resourcesIncludes normal profitLO26-*Accounting Profit and Normal ProfitAccounting profit = Revenue – Explicit costsEconomic profit = Accounting profit – Implicit costsEconomic profit (to summarize) = Total revenue – Economic costs = Total revenue – Explicit costs – Implicit CostsLO26-*Economic ProfitLO2ExplicitcostsAccounting costs (explicit costs only)Implicit costs (including a normal profit)EconomicprofitAccounting profitEconomic(Opportunity)CostsTotal Revenue6-*Short Run and Long RunShort runSome variable inputsFixed plantLong runAll inputs are variableVariable plantFirms enter and exitLO36-*Short-Run Production RelationshipsTotal product (TP)Marginal product (MP)Average product (AP) LO3Marginal productChange in total productChange in labor input=Average productTotal productUnits of labor=6-*Law of Diminishing ReturnsResources are of equal qualityTechnology is fixedVariable resources are added to fixed resourcesAt some point, marginal product will fallRationaleLO36-*The Law of Diminishing ReturnsLO3Total, Marginal, and Average Product: The Law of Diminishing Returns(1)Units of the Variable Resource (Labor)(2)Total Product (TP)(3)Marginal Product (MP)Change in (2)/ Change in (1)(4)Average Product (AP),(2)/(1)00-11010Increasingmarginalreturns10.002251512.503452015.0046015Diminishingmarginalreturns15.005701014.00675512.50775010.71870-5Negativemarginalreturns8.756-*The Law of Diminishing ReturnsLO3TPMPAPIncreasingMarginalReturnsDiminishingMarginalReturnsNegativeMarginalReturns1234567890102030Total Product, TP1234567892010Marginal Product, MP6-*Short-Run Production CostsFixed costs (TFC)Costs do not vary with outputVariable costs (TVC)Costs vary with outputTotal costs (TC)Sum of TFC and TVCTC = TFC + TVCLO46-*Per-Unit, or Average, CostsAverage fixed costs AFC = TFC/QAverage variable costs AVC = TVC/QAverage total costs ATC = TC/QMarginal costs MC =ΔTC/ΔQLO46-*Short-Run Production CostsLO4Total, Average, and Marginal Cost Schedules for an Individual Firm in the Short RunTotal Cost DataAverage Cost DataMarginal Cost(1)Total Product (Q)(2)Total Fixed Cost (TFC)(3)Total Variable Cost(TVC)(4)Total Cost (TC)TC = TFC + TVC(5)Average Fixed Cost(AFC)AFC = TFC/Q(6)AverageVariableCost (AVC)AVC=TVC/Q(7)Average Total Cost(ATC)ATC = TC/Q(8)Marginal Cost(MC)MC =ΔTC/ΔQ0$100$0$100110090190$100.00$90.00$190.00$90210017027050.0085.00135.0080310024034033.3380.00113.3370410030040025.0075.00100.0060510037047020.0074.0094.0070610045055016.6775.0091.6780710054064014.2977.1491.4390810065075012.5081.2593.75110910078088011.1186.6797.7813010100930103010.0093.00103.001506-*Marginal CostLO4Costs123456789100Q50100150$200AFCMCATCAVCAVCAFC6-*Long-Run Production CostsThe firm can change all input amounts, including plant sizeAll costs are variable in the long runLong-run ATCDifferent short-run ATCsLO56-*Firm Size and CostsLO5Average Total CostsATC-1ATC-2ATC-3ATC-4ATC-5Output6-*The Long-Run Cost Curve LO4Long-runATCAverage Total CostsATC-1ATC-2ATC-3ATC-4ATC-5Output6-*Economies and Diseconomies of ScaleEconomies of scaleLabor specializationManagerial specializationEfficient capitalOther factorsConstant returns to scaleLO56-*Economies and Diseconomies of ScaleDiseconomies of scaleControl and coordination problemsCommunication problemsWorker alienationShirkingLO56-*MES and Industry StructureMinimum efficient scale (MES):Lowest level of output where long-run average costs are minimizedCan determine the structure of the industryLO56-*MES and Industry StructureLO5OutputAverage Total CostsLong-runATCEconomiesof ScaleConstant Returnsto ScaleDiseconomiesof Scaleq1q26-*MES and Industry StructureLO5OutputAverage Total CostsEconomiesof ScaleDiseconomiesof ScaleLong-runATC6-*MES and Industry StructureLO5OutputAverage Total CostsEconomiesof ScaleDiseconomiesof ScaleLong-runATC6-*