6
#
Businesses and Their Costs
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
The Business Population
• Plant
• Factory, farm, mine, store, website,
•
•
LO1
warehouse
Firm
• Operates one or more plants
Industry
• Group of firms that produce the
same products
6-2
Corporation Advantages
• Stocks
• Ownership shares of a corporation
• Bonds
• Liabilities of a corporation
• Limited liability
LO1
6-3
Principal-Agent Problem
• Principals
• Stockholders
• Agents
• Executives
LO1
6-4
Economic Costs
• The payment that must be made to
•
•
LO2
obtain and retain the services of a
resource
Explicit costs
• Monetary payments
Implicit costs
• Value of next best use
• Self-owned resources
• Includes normal profit
6-5
Accounting Profit and Normal Profit
• Accounting profit
•
•
LO2
= Revenue – Explicit costs
Economic profit
= Accounting profit – Implicit costs
Economic profit (to summarize)
= Total revenue – Economic costs
= Total revenue – Explicit costs –
Implicit Costs
6-6
Economic Profit
LO2
Implicit costs
(including a
normal profit)
Explicit
costs
Total Revenue
Economic
(Opportunity)
Costs
Economic
profit
Accounting
profit
Accounting
costs (explicit
costs only)
6-7
Short Run and Long Run
• Short run
• Some variable inputs
• Fixed plant
• Long run
• All inputs are variable
• Variable plant
• Firms enter and exit
LO3
6-8
Short-Run Production Relationships
• Total product (TP)
• Marginal product (MP)
Marginal product
=
Change in total product
Change in labor input
• Average product (AP)
Average product
LO3
=
Total product
Units of labor
6-9
Law of Diminishing Returns
• Resources are of equal quality
• Technology is fixed
• Variable resources are added to fixed
•
•
LO3
resources
At some point, marginal product will
fall
Rationale
6-10
The Law of Diminishing Returns
Total, Marginal, and Average Product: The Law of Diminishing
Returns
LO3
(1)
Units of the
Variable
Resource
(Labor)
(3)
Marginal
Product (MP)
Change in (2)/
Change in (1)
(2)
Total Product
(TP)
0
0
1
10
10
2
25
15
3
45
20
15.00
4
60
15
15.00
5
70
10
6
75
5
7
75
0
8
70
-5
(4)
Average
Product (AP),
(2)/(1)
Increasing
marginal
returns
10.00
12.50
Diminishin
g
marginal
returns
14.00
Negative
marginal
returns
8.75
12.50
10.71
6-11
Total Product, TP
The Law of Diminishing Returns
30
TP
20
10
0
Marginal Product, MP
1
LO3
20
2
3
Increasing
Marginal
Returns
4
5
6
7
8
9
Negative
Marginal
Returns
Diminishing
Marginal
Returns
10
AP
1
2
3
4
5
6
7
8 9
MP
6-12
Short-Run Production Costs
• Fixed costs (TFC)
• Costs do not vary with output
• Variable costs (TVC)
• Costs vary with output
• Total costs (TC)
• Sum of TFC and TVC
• TC = TFC + TVC
LO4
6-13
Per-Unit, or Average, Costs
• Average fixed costs
• Average variable costs
• Average total costs
• Marginal costs
LO4
AFC = TFC/Q
AVC = TVC/Q
ATC = TC/Q
MC = ΔTC/ΔQ
6-14
Short-Run Production Costs
Total, Average, and Marginal Cost Schedules for an Individual Firm in the Short Run
Total Cost Data
LO4
Average Cost Data
Marginal Cost
(5)
Average
Fixed Cost
(AFC)
AFC =
TFC/Q
(6)
Average
Variable
Cost
(AVC)
AVC=TVC/Q
(7)
Average
Total
Cost
(ATC)
ATC =
TC/Q
190
$100.00
$90.00
$190.00
$90
170
270
50.00
85.00
135.00
80
100
240
340
33.33
80.00
113.33
70
4
100
300
400
25.00
75.00
100.00
60
5
100
370
470
20.00
74.00
94.00
70
6
100
450
550
16.67
75.00
91.67
80
7
100
540
640
14.29
77.14
91.43
90
8
100
650
750
12.50
81.25
93.75
110
9
100
780
880
11.11
86.67
97.78
130
10
100
930
1030
10.00
93.00
103.00
150
(1)
Total
Product
(Q)
(2)
Total
Fixed
Cost
(TFC)
(3)
Total
Variable
Cost
(TVC)
(4)
Total Cost
(TC)
TC = TFC
+ TVC
0
$100
$0
$100
1
100
90
2
100
3
(8)
Marginal Cost
(MC)
MC =ΔTC/ΔQ
6-15
Marginal Cost
$200
MC
150
Costs
AFC
ATC
100
AVC
50
AVC
AFC
0
LO4
1
2
3
4
5
6
7
8
9
10
Q
6-16
Long-Run Production Costs
• The firm can change all input
•
•
LO5
amounts, including plant size
All costs are variable in the long run
Long-run ATC
• Different short-run ATCs
6-17
Average Total Costs
Firm Size and Costs
ATC-1
ATC-5
ATC-2
ATC-3
ATC-4
Output
LO5
6-18
Average Total Costs
The Long-Run Cost Curve
ATC-1
ATC-5
ATC-2
ATC-3
ATC-4
Long-run
ATC
Output
LO4
6-19
Economies and Diseconomies of Scale
• Economies of scale
• Labor specialization
• Managerial specialization
• Efficient capital
• Other factors
• Constant returns to scale
LO5
6-20
Economies and Diseconomies of Scale
• Diseconomies of scale
• Control and coordination problems
• Communication problems
• Worker alienation
• Shirking
LO5
6-21
MES and Industry Structure
• Minimum efficient scale (MES):
• Lowest level of output where longrun average costs are minimized
• Can determine the structure of the
industry
LO5
6-22
Average Total Costs
MES and Industry Structure
Diseconomies
of Scale
Constant Returns
to Scale
Economies
of Scale
Long-run
ATC
q1
q2
Output
LO5
6-23
Average Total Costs
MES and Industry Structure
Economies
of Scale
Diseconomies
of Scale
Long-run
ATC
Output
LO5
6-24
Average Total Costs
MES and Industry Structure
Economies Diseconomies
of Scale
of Scale
Long-run
ATC
Output
LO5
6-25