Producer: Production and Cost PDF

Producer: Production and Cost Assistant Professor Dr. Nattapan Kongbuamai Economics Major, School of Management Mae Fah Luang University Objectives When you have completed your study of this chapter, you will be able to Define the conc...

Producer: Production and Cost Assistant Professor Dr. Nattapan Kongbuamai Economics Major, School of Management Mae Fah Luang University Objectives When you have completed your study of this chapter, you will be able to Define the concept of profit. Define and calculate the production concept. Define and calculate the cost concept. Define and calculate the revenue concept. What is the goal of the firm? The goal of the firm (Firm’s Objective) is to maximize profit!!! BUT..........What is profit? Concept of Profit Total Revenue (TR) The amount a firm receives for the sale of its output. Total Cost (TC) The market value of the inputs a firm uses in production. Profit The firm’s total revenue minus its total cost Profit = Total revenue - Total Cost (Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.260) Economic Profit VS Accounting Profit Economists measure a firm’s economic profit as total revenue minus total cost including both firm’s explicit and implicit costs. Accountants measure the firm’s accounting profit as the firm’s total revenue minus only the firm’s explicit costs. When total revenue exceeds both explicit and implicit costs, the firm earns economic profit. When total revenue exceeds explicit costs, the firm earns accounting profit. (Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.262)  Types of CostTotal Cost = Explicit cost + Implicit cost Explicit cost Input costs that require an outlay of money by the firm. (Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. P. 261). Payment to nonowners of a firm for their resources. (Source: Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning. p. 109) E.g. Money actually paid out for the use of inputs (wage, rent, etc.) Implicit cost Input cost that do not require an outlay of money by the firm. (Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. P. 261). The opportunity costs of using resources owned by the firm. (Source: Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning. p. 109) E.g. the cost of input for which there is no direct money payment. Imagine that Caroline is skilled with computers and could earn $100 per hour working as a progammer. For every hour that Carolina works at her cookie factory, she gives up $100 in income, and this forgone income is her implicit cost. Economic Profit VS Accounting Profit  Exercise I: Economic Profit VS Accounting Profit Please calculate the Accounting and Economic Profit (Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South- Western Cengage Learning. P.110) Normal Profit (Zero Economic Profit) The minimum profit necessary to keep a firm in operation. A firm that earns normal profits earns total revenues equal to its total opportunity cost. Total revenues = Total opportunity cost = Normal Profit Total revenues > Total opportunity cost = ? Total revenues < Total opportunity cost = ? Zero economic profit signifies there is just enough total revenue to pay the owners for all explicit and implicit costs. (Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South- Western Cengage Learning. P.110)  Cost and Time Period Costs of production may be divided into fixed costs and variable costs. Fixed Inputs/ Fixed Costs/Fixed Resources Inputs/Costs that do not vary with the quantity of output produced. (Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.266) Any resource for which the quantity cannot change during the period of time under consideration. (Source: Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning. p. 111) Variable Inputs/Variable Costs/Variable Resources Inputs/Cost that vary with the quantity of output produced. (Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.266) Any resource for which the quantity can change during the period of time under consideration. (Source: Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning. p. 111) Short Run A period of time so short that there is at least one fixed inputs. (Source: Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning. p. 111) Long run A period of time so long that all inputs are variable. (Source: Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning. p. 111) Short Run and Long Run Short Run: Fixed Plant The time frame in which the quantities of some resources (fixed factors of production) are fixed. For most firms, the fixed resources are the firm’s technology and capital- its equipment and buildings. To increase output in short run, a firm must increase the quantity of variable factors of production e.g. number of labor or hours it hires. Long Run: Variable Plant The time frame in which the quantities of all resources (factors of production) can be varied. So, in long run, the firm can change its plant. For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered. In the short run, some costs are fixed. In the long run, all fixed costs become variable costs. Production Concept Short Run Production To increase output with a fixed plant, a firm must increase the quantity of labor it uses. We describe the relationship between output and the quantity of labor by using three related concepts: Total product Marginal product Average product Short Run Production Total Product Total product (TP) is the total quantity of a good produced in a given period. Total product is an output rate—the number of units produced per unit of time. Total product increases as the quantity of labor employed increases.  Short Run Production The Total Product Curve. Points A through H on the curve correspond to the columns of the table. The TP curve is like the PPF: It separates attainable points and unattainable points. Short Run Production Alternative Different Production Input Quantities of Function Combination output The production function shows the relationship between quantity of inputs used to make a good and the quantity of output of that good. Marginal Product of any input in the production process is the increase in output that arises from an additional unit of that input. Marginal Product of Labor (MPL) is the change in total product (∆Q) divided by the change in the number of workers hired (∆L). It shows the rise in output produced when one more worker is hired. Short Run Production Marginal Product Marginal product of labor is the change in total product that results from a one-unit increase in the quantity of labor employed. Marginal product of labor tells us the contribution to total product of adding one more worker. Marginal Change in Change in product = total product  quantity of labor Q MPL = L Short Run Production Average Product Average product is the average amount produced by each unit of a variable factor of production. Average product is the total product per worker employed. It is calculated as: Another name for average product is productivity. Total Product TP Average product = AP = Labor L  Please draw a graph with 2 lines of AP (X-axis: Number of Workers, Y- axis: AP) and MPL (X-axis: Number of Workers, Y-axis: MPL) Exercise II: Short Run Production Find the Marginal Product of Labor, Total Cost, and Average Product Average Product of Labor ______ (Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.264) Short Run Production Increasing Marginal Returns Increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal product of the previous worker. Increasing marginal returns occur when a small number of workers are employed and arise from increased specialization and division of labor in the production process. Short Run Production Decreasing Marginal Returns Decreasing marginal returns occur when the marginal product of an additional worker is less than the marginal product of the previous worker. Decreasing marginal returns arise from the fact that more and more workers use the same equipment and work space. As more workers are employed, there is less and less that is productive for the additional worker to do. Short Run Production Decreasing marginal returns are so pervasive that they qualify for the status of a law: The law of decreasing returns states that: As a firm uses more of a variable input, with a given quantity of fixed inputs, the marginal product of the variable input eventually decreases. Short Run Production The figure graphs the average product against the quantity of labor employed. The average product curve is AP.  Average product is at its maximum at the point of intersection with marginal product. Short Run Production When marginal product exceeds average product, average product is increasing. When marginal product is less than average product, average product is decreasing. When marginal product equals average product, average product is at its maximum. Cost Concept Short Run Cost To produce more output in the short run, a firm employs more labor, which means the firm must increase its costs. We describe the relationship between output and cost using three cost concepts: Total cost Marginal cost Average cost The Various Measures of Cost Total Costs The market value of the inputs a firm uses in production. Total Fixed Costs (TFC) Total Variable Costs (TVC) Total Costs (TC) TC = TFC + TVC Average Costs Average costs can be determined by dividing the firm’s costs by the quantity of output it produces. The average cost is the cost of each typical unit of product. Total Fixed Costs /Quantity = Average Fixed Costs (AFC) Total Variable Costs / Quantity = Average Variable Costs (AVC) Total Costs / Quantity = Average Total Costs (ATC) ATC = AFC + AVC How to calculate Average cost? Total Fixed Cost TFC AFC = = Quantity Q Total Variable Cost TVC AVC = = Quantity Q Total Cost TC ATC = = Quantity Q AVC and ATC get closer together as output increases, but the two lines never meet. The Various Measures of Cost Marginal Cost Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production. Marginal cost helps answer the following question: - How much does it cost to produce an additional unit of output? (change in total cost) TC MC = = (change in quantity) Q  1. Please draw a graph with 3 lines of TC, TFC, and TVC curve (X axis: Q) 2. Please draw a graph with 3 lines of ATC, AVC and MC curve (X axis: Q) Exercise III: Short Run Cost  Short Run Cost The TFC curve does not vary with output. The shape of the TC curve is determined by the shape of the TVC curve. The vertical distance between the TC and the TVC curves is TFC. Case, K. E., Fair, R. C., & Oster, S. M. (2017). Principles of Macroeconomics (12th ed.). Essex: Pearson Education Limited.  Whenever marginal cost is less than average total cost, average total cost is falling. Short Run Cost Whenever marginal cost is greater than average total cost, average total cost is rising. AFC is also the difference between the ATC and the AVC curves at any quantity of output. MC hits minimum point of ATC, AVC Case, K. E., Fair, R. C., & Oster, S. M. (2017). Principles of Macroeconomics (12th ed.). Essex: Pearson Education Limited. The relationship between marginal cost and average cost This relationship is called the marginal-average rule. The marginal-average rule states that when marginal cost is below average cost, average cost falls. When marginal cost is above average cost, average cost rises. When marginal cost equals average cost, average cost is at its minimum point. (Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South- Western Cengage Learning. P.110)  Conclusion: Cost Curves and Product Curves Marginal cost eventually rises with the quantity of output. The marginal cost (MC) curve is a J-shaped curve. The average-total-cost curve is an U-shaped curve. Average total cost declines as output increases. ATC starts raising because variable cost rises substantially. The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost. The bottom of the U-shaped ATC curve occurs at the quantity that minimizes ATC, this quantity is sometime called the efficient scale of the firm. The marginal-cost curve crosses the average-total-cost curve at the efficient scale. - Efficient scale is the quantity that minimizes average total cost. Whenever marginal cost is less than average total cost, average total cost is falling. Whenever marginal cost is greater than average total cost, average total cost is rising. MC hits both ATC and AVC at their minimum points. Conclusion: Cost Curves and Product Curves At low levels of employment and output, as the firm hires more labor, marginal product and average product rise, and marginal cost and average variable cost fall. Then, at the point of maximum marginal product, marginal cost is a minimum. As the firm hires more labor, marginal product decreases and marginal cost increases. Then, at the point of maximum average product, average variable cost is a minimum. If marginal product rises, marginal cost falls. If marginal product is a maximum, marginal cost is a minimum. If average product rises, average variable cost falls. If average product is a maximum, average variable cost is a minimum. Conclusion: Cost Curves and Product Curves At small outputs, MP and AP rise and MC and AVC fall. At intermediate outputs, MP falls and MC rises and AP rises and AVC falls. At large outputs, MP and AP fall and MC and AVC rise. Case, K. E., Fair, R. C., & Oster, S. M. (2017). Principles of Macroeconomics (12th ed.). Essex: Pearson Education Limited.  Long Run Long-run average cost curve (LRAC) shows the way per unit costs change with output in the long run. Long-run average cost curve (LRAC) is the curve that traces the lowest cost per unit at which a firm can produce any level of output when the firm can build any desired plant size. The shape of a firm’s long-run average cost curve shows how costs vary with scale of operation. In some firms, production technology is such that increased scale, or size, reduces average or per unit costs. A firm operates in the short run when there is insufficient time to alter some fixed input. The firm plans in the long run when all inputs are variable. Case, K. E., Fair, R. C., & Oster, S. M. (2017). Principles of Macroeconomics (12th ed.). Essex: Pearson Education Limited. (Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning.)  Because many costs are fixed in the short run Cost in the Long Run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves. The long run ATC curve is often called the firm’s planning curve. The long-run average-total- cost curve has a much flatter U-shape than the short-run average total-cost curve. There is no single answer to the question of how long it takes a firm to adjust its production facilities. Source: Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.272)  Economic of scale: A situation in which the long-run average cost curve declines as the firm increases output. Constant returns to scale: A situation in which the long-run average cost curve does not change as the firm increases output. Diseconomic of scale: A situation in which the long-run average cost curve rises as the firm increase output. (Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South- Western Cengage Learning. P.118-121) Revenue Concept Revenue Total Revenue (TR) The amount a firm receives for the sale of its output. TR = Price * Quantity =P * Q Marginal Revenue (MR) measures the increase in total revenue that arises from an extra unit of production. Marginal revenue helps to define how much the revenue to produce an additional unit of output? Change in Total Revenue ∆TR MR = = Change in Quantity ∆Q Average Revenue (AR) It tells us how much revenue a firm receives for the typical unit sold. Average revenue is total revenue divided by the quantity sold.  Unit price is $1.5 Exercise IV: Short Run Cost Break Even Point Vocabulary Market Perfect Perfectly competitive market Imperfect Oligopoly Competition Monopoly Manufacturer Monopolistic Factory Short run Firm Long run Company Word for Today “It Ain’t How Hard You Hit…It’s How Hard You Can Get Hit and Keep Moving Forward. It's About How Much You Can Take And Keep Moving Forward!” ― Sylvester Stallone, Rocky Balboa  Further Reading Mankiw, N. G., 2012. Principles of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.259-277. Tucker, I. B., 2009. Essentials of Economics. 6th ed. s.l.:South-Western Cengage Learning. p.108-126. Case, K. E., Fair, R. C., & Oster, S. M. (2017). Principles of Macroeconomics (12th ed.). Essex: Pearson Education Limited. P.198-242