Announcements Ec100 Economics for Business

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Announcements Ec100 Economics for Business
This week Week 3s material Consumer choice
problem consumers surplus interpretation of
demand risk preferences insurance adverse
selection and moral hazard Office hours,
revision problems, also textbooks CD Week 4
material problem set 4 in class Week 5
material lecture, read chapter 9 Assignment
posted on website. try NEW question 2.
DUE December 8th
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Marking Process Standard of answer
Marking Class teacher/module supervisor
Criteria for good answer answers the question
grasp of
the topic
economic reasoning
specifies assumptions
organised
clear
mathematically accurate
neat
cites
sources The right answer may not be
unique Link your text to the graphs and maths.
Explain your definitions and concepts to a
non-economist friend. If you cannot get a
numerical answer where one is requested, you may
not be putting enough structure on the problem.
If your answer is not internally consistent, you
may be making unjustified assumptions.
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Costs of Production Chapter 9
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Introduction

• Supply side Production and Costs
• Production functions
• Short run/Long Run
• Key Descriptors
• Standard characteristics
• Cost Curves
• Short run/Fixed Costs Long run/Variable costs
• Key descriptors
• Long run scale of operation

5
Our model of the firm
inputs
outputs
production function transforms inputs into
outputs
technology determines how
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Production in the Short run

• Production functions
• factors of production (inputs)
• labour
• land and raw materials
• capital
• the relationship between inputs and output
• TPP Q (F1, F2, F3, Fn)

7
Our model of the firm
Short run ONE of Fs is fixed (cant
change) Long run ALL Fs variable (can change)
F1, F2 , F3,
TPP Q
f(F1, F2, F3.)
technology determines what f uses/does
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Production in the Short run

• Long-run and short-run production
• fixed and variable factors
• distinction between short run and long run
• The law of diminishing returns
• The short-run production function
• total physical product (TPP Q)
• average physical product (APP Q/F)
• marginal physical product (MPP ?Q/?F)
• the graphical relationship between TPP, APP and
  MPP

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Wheat production per year from a particular farm
Number of workers 0 1 2 3 4 5 6 7 8
TPP 0 3 10 24 36 40 42 42 40
Tonnes of wheat produced per year
Number of farm workers
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Wheat production per year from a particular farm
d
TPP
Tonnes of wheat produced per year
b
Number of farm workers
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Wheat production per year from a particular farm
TPP
Tonnes of wheat per year
Number of farm workers (L)
Tonnes of wheat per year
APP
Number of farm workers (L)
MPP
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Wheat production per year from a particular farm
TPP
Tonnes of wheat per year
Number of farm workers (L)
Tonnes of wheat per year
APP
Number of farm workers (L)
MPP
13
Wheat production per year from a particular farm
TPP
Tonnes of wheat per year
b
Number of farm workers (L)
b
Tonnes of wheat per year
APP
Number of farm workers (L)
MPP
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Wheat production per year from a particular farm
d
TPP
Tonnes of wheat per year
b
Number of farm workers (L)
b
Tonnes of wheat per year
APP
d
Number of farm workers (L)
MPP
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Q If the marginal physical product (MPP) is
above the average physical product (APP),

• the MPP must be falling.
• the MPP must be rising.
• the APP must be falling.
• the APP must be rising.
• the APP could be either rising or falling
  depending on whether the MPP is rising or
  falling.

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The Meaning of Costs

• Opportunity costs
• opportunity cost concept of cost underlying
  models of choice
• Measuring a firms opportunity costs
• factors not owned by the firm explicit costs
• factors already owned by the firm implicit costs
• historic costs irrelevant
• replacement costs relevant only if replacing
  something

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Costs in the Short run

• Costs and inputs
• costs and the productivity of factors
• costs and the price of factors
• Fixed costs and variable costs

• Total costs
• total fixed cost (TFC)
• total variable cost (TVC)
• TVC and the law of diminishing returns
• total cost (TC TFC TVC)

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Q Which of the following is a fixed cost for a
handmade furniture manufacturer?

• The cost of wood
• Labour costs
• The rent on the workshop
• The cost of glue and screws
• The cost of electricity for running the machines

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Total costs for firm X

Output (Q) 0 1 2 3 4 5 6 7
TVC () 0 10 16 21 28 40 60 91
TC () 12 22 28 33 40 52 72 103
TFC () 12 12 12 12 12 12 12 12
TC
TVC
TFC
output
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Total costs for firm X

TC
TVC
TFC
output
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Costs in the Short run

• Average cost
• average fixed cost (TFC/Q)
• average variable cost (TVC/Q)
• average (total) cost (TC/Q) AFC AVC
• Marginal cost ?TC/ ?Q

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Total, average and marginal cost for Firm X
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Average and marginal costs
Costs ()
Output (Q)
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Short-run Costs

• Average and marginal cost curves
• marginal cost
• relationship between average and marginal cost
  curves

25
Average and marginal costs
Costs ()
Output (Q)
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Relation between average and marginal

• Students walk into classroom.
• The marginal height of students in the room is
  the height of the last person to walk in.
• The average height of students in the room is the
  total height divided by the number of students.

Name height total height average
height (in room) marginal height Jim
170cm 170 cm 170cm
170cm Kate 160cm
330 cm 165cm
160cm Ali 180cm 510 cm
170 cm
180 cm
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Q If the marginal cost is below the average
cost, then

• the marginal cost must be falling.
• the marginal cost must be rising.
• the average cost must be falling.
• the average cost must be rising.
• the average cost could be either rising or
  falling depending on whether the marginal cost is
  rising or falling.

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Pause

• Production function describes how inputs are
  transformed into outputs
• Describing short run production diminishing
  marginal returns TPP, APP, MPP
• Describing short run costs Fixed Costs, Variable
  Costs TC, AC, MC
• Marginal lt Average ? average falling
• Marginal gt Average ? average rising

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Production in the Long run

• All factors variable in long run
• The scale of production
• constant returns to scale
• increasing returns to scale

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Short-run and long-run increases in output
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Production in the Long run

• All factors variable in long run
• The scale of production
• constant returns to scale
• increasing returns to scale
• decreasing returns to scale
• Returns to scale and economies and diseconomies
  of scale

Economies of scale
Diseconomies of scale
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Production in the Long run

• Economies of scale
• specialisation division of labour
• indivisibilities
• container principle
• greater efficiency of large machines
• by-products
• multi-stage production
• organisational administrative economies
• Economies of scope

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Production in the Long run

• Diseconomies of scale
• managerial diseconomies/coordination
• effects of workers and industrial relations
• production interdependencies/coordination
• External economies of scale
• External diseconomies of scale
• Location
• balancing the distance from suppliers and
  consumers to minimise transport costs

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Costs in the Long run

• Long-run costs
• no fixed costs law of diminishing returns does
  not apply but economies/diseconomies of scale
  may
• shape of the LRAC curve
• assumptions behind the curve
• factor prices fixed at each level of output
• technology does not change
• firms operate efficiently our LRAC curve does
• not incorporate waste

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Alternative long-run average cost curves
Economies of Scale
Costs
O
Output
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Alternative long-run average cost curves
Diseconomies of Scale
Costs
O
Output
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Alternative long-run average cost curves
Constant costs
Costs
O
Output
38
A typical long-run average cost curve
Costs
O
Output
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A typical long-run average cost curve
Economies of scale
Constant costs
Diseconomies of scale
Costs
specialisation
Coordination problems
O
Output
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Costs in the Long run

• Long-run marginal costs
• Relationship between long-run and short-run
  average costs
• the envelope curve
• minimum efficient scale

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Long-run average and marginal costs
Economies of Scale
Costs
LRAC
O
Output
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Long-run average and marginal costs
LRAC
Diseconomies of Scale
Costs
O
Output
43
Long-run average and marginal costs
Constant costs
Costs
LRAC
LRMC
O
Output
44
Long-run average and marginal costs
Initial economies of scale, then diseconomies of
scale
LRAC
Costs
O
Output
45
Deriving long-run average cost curves factories
of fixed size
1 factory
Costs
2 factories
3 factories
O
Output
46
Deriving long-run average cost curves factories
of fixed size
SRAC5
SRAC1
SRAC2
SRAC4
SRAC3
LRAC
Costs
O
Output
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Deriving a long-run average cost curve choice of
factory size
LRAC
Costs
O
Output
48
Deriving a long-run average cost curve choice of
factory size
LRAC
Costs
Minimum Efficient Scale
O
Output
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Minimum efficient scale for various plants
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Production in the Long run Postscript

• Efficient combination of factors
• MPPa/Pa MPPb/Pb ... MPPn/Pn
• For each input, I get no more out of spending
  one pound of my budget on any other factor
  combination
• Decision making in different time periods
• very short run
• short run
• long run
• very long run
• decisions can be made for all time periods at the
  same time

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Summary

• Economic costs are Opportunity Costs
• Production functions
• Short run/Long Run
• TPP (Q), APP, MPP
• law of diminishing (marginal) returns
• Cost Curves
• Short run/Fixed Costs Long run/Variable costs
• TC, AC, MC
• Economies of Scale/Minimum Efficient Scale