University:
California State University, Northridge
Course:
ECON 160 | Principles of Microeconomics
Academic year:

2024
Views:

381

Pages:

25
Author:

Mercedes Bishop

Production, Inputs, and Cost: Building Blocks for Supply Analysis Cost Curves and Input Quantities ● 3 different cost curves –Total Cost (TC), Average Cost (AC), and Marginal Cost (MC). ● Flo’s costs depend on Q of inputs and on P of those inputs. ● To calculate costs, assume: ♦ P corn is beyond Flo's control. ♦ Q of all other inputs (except corn) are fixed. ♦ P corn = $10 per 40 lb. bag TABLE 3. TPP, TC, and AC for Flo’s Chicken Farm TPP of chicken (lbs. per week) Corn input (bags per week) Total Cost (per week) Average Cost (TC/Q output) 0 0 0 0.00 14 1 10 0.71 36 2 20 0.56 66 3 30 0.45 100 4 40 0.40 130 5 50 0.38 156 6 60 0.38 175 7 70 0.40 184 8 80 0.43 185.4 9 90 0.49 Cost Curves and Input Quantities ● TPP → Q output firm can produce given Q inputs. Q inputs and P inputs → firm can determine TC of producing any Q output. ● TC = P inputs x Q inputs ● AC = TC/Q output ♦ E.g., TC 100 lbs = $40 → AC = $40/100 = $0.40 ● MC = ∆TC when output increases by 1 unit ♦ E.g., if TC 100 lbs. = $40.00 TC 99 lbs. = $39.70 MC 100th lb. = $0.30 ♦ Note: table above doesn’t show this because ↑output > 1. FIGURE 3. Flo’s Total Cost Curve Total Cost ($ / week) Total Cost 100 90 80 70 60 50 40 30 20 10 0 0 50 100 150 Quantity of Chicken (lbs / week) 200 FIGURE 4. Flo’s Average Cost and Marginal Cost Curves AC and MC MC AC 0 Q of chicken AC and MC typically ↓ and then ↑ as the ↑output level. Fixed and Variable Costs ● TC, AC, and MC can be divided into 2 parts –fixed costs and variable costs. ● Fixed cost is the cost of an input whose Q does not ↑ when ↑output. Input that the firm requires to produce any output. Any other cost is a variable cost. ♦ E.g., takes at least 1 taxi to run a cab co. and its cost is the same whether 1 or 60 people ride in it. But gas use rises as more people ride. Taxi is a fixed cost and gas is a variable cost. What are the fixed and variable costs where you work? Fixed and Variable Costs ● TC = TVC + TFC ● AC = AVC + AFC ♦ AC = TC/Q output ♦ AVC = TVC/Q output ♦ AFC = TFC/Q output Table 4. Flo’s Total and Average Fixed Costs Output (20 lb pack) TFC $ / week AFC $ / week 0 5.0 --- 1 5.0 5.00 2 5.0 2.50 3 5.0 1.70 4 5.0 1.25 5 5.0 1.00 6 5.0 0.80 7 5.0 0.70 8 5.0 0.60 Flo pays rent of $5 per week for her chicken coop. FIGURE 5. Graph of Flo’s Total Fixed Cost TFC $5 0 TFC 6 8 10 Q (20 lb. packages) FIGURE 6. Graph of Flo’s Average Fixed Cost AFC If Flo produces 1 package, TFC is carried by 1. But if she produces 4, TFC gets divided between 4 packages. So $5.00 ↓AFC as ↑output. $1.25 $0.70 0 AFC 1 4 7 Q (20 lb. packages) FIGURE 7. Flo’s Total Variable Cost Curve TVC TVC $125 $57 0 6 10 Q TVC has same shape as TC because ↑variable costs as ↑output. Fixed and Variable Costs ● Marginal Cost = Marginal Variable Cost (MVC) Why doesn't MC have a fixed component (i.e., MC = MVC + MFC)? Shape of the Average Cost Curve ● AC is generally U shaped –it initially declines and eventually rises with the level of output. ● AC declines for 2 reasons: 1. Changing input proportions: at first, Flo feeds chickens more corn while holding all other inputs constant. Output rises rapidly when ↑MPP corn, which tends to ↓AC. 2. ↓Average fixed costs as ↑output. Shape of the Average Cost Curve ● AC eventually rises for 2 reasons: 1. Dim MPP: ↑output more slowly as ↓MPP corn, which tends to ↑AC. 2. Bureaucratic mess: as firms grow in size they lose personal touch of management and become increasingly bureaucratic, which drives up costs. ● Point where ↑AC varies by industry. AC in auto industry begins ↑ after more units of output than farming. Huge K investment → AFC↓ dramatically. Short-run versus Long-run Costs ● Cost of changing a firm's output level depends on period of time under consideration. Many input choices are precommitted by past decisions. ● Sunk cost = a cost to which a firm is precommitted for some limited period of time. ♦ E.g., a 2-year-old machine with a 9-year economic life is a variable cost after 7 years because the machine would have to be replaced anyway. Short-run versus Long-run Costs ● SR = period of time when some of the firm's cost commitments end. ● LR = period of time when all of the firm's cost commitments end. ● There are no fixed costs in LR –all costs are variable. ♦ E.g., if # of workers can be altered daily, and # of machines altered yearly, and size of plant every 10 years. Then 10 years is the LR. Short-run versus Long-run Costs ● Size of a firm may be fixed in SR because it has purchased or leased a particular plant, but firm can alter size of its plant in LR. ♦ E.g., Flo has already built a chicken coop, which restricts her ability to ∆ output level in SR. In LR, Flo can build a new larger coop to produce more. Average Cost Curve in the Short and Long Run ● LR AC curve differs from SR AC curve because all inputs are variable in LR. ♦ E.g., In SR, Flo can only chose how many chickens to squeeze into coop. In LR, she can chose among different coop sizes. FIGURE 8. Flo’s SR and LR Average Cost Curves AC (per package) $16 $12 B L S U $9 40 T V 100 G Q (20 lb. packages) Average Cost Curve in the Short and Long Run ● If Flo expects to sell 40 → she buys a small coop with AC of SL. If Q = 40 → AC = $12 (pt U). ● She is surprised by strong D and can sell 100 with AC = $12 (pt V). ● Now she needs a bigger coop with AC of BG with its lower AC of $9 for Q = 100. ● In SR, Flo is stuck with AC of SL. In LR, she can replace coop and the relevant AC is STG. ● LR AC curve shows the lowest possible SR AC for each output level. Economies of Scale ● Returns to scale indicates how the output level changes when all the firm's inputs are doubled. 1. Increasing Returns to Scale (IRTS): Q output more than doubles. ● IRTS gives a cost advantage to larger firms. Found in industries like telecommunications, electricity, automobiles, and aircraft. 2. Constant Returns to Scale (CRTS): Q output doubles. 3. Decreasing Returns to Scale (DRTS): Q output less than doubles. ● Gives a cost advantage to smaller firms. Most U.S. industries have DRTS. Economies of Scale ● Returns to scale impacts the shape of the AC curve. ● AC = TC/Q output = (P input x Q input)/Q output ♦ E.g., if Q inputs doubles and Q output doubles, then AC is constant. AC Quantity of Output (a) Constant returns to scale AC Quantity of Output (b) Long-Run Average Cost Increasing returns to scale Long-Run Average Cost Long-Run Average Cost FIGURE 9. 3 Possible Shapes for the AC Curve Decreasing returns to scale Quantity of Output (c) AC Economies of Scale ● Law of dim. marginal returns and IRTS may seem contradictory, but they are unrelated. ● Dim. marginal returns refers to increasing a single input. Returns to scale refers to a doubling of all inputs. ● A firm with dim. returns to a single input could have IRTS, CRTS, or DRTS.