economics ch.9

Marginal Cost & Marginal Product

Marginal cost is a reflection of marginal product and diminishing returns. When diminishing returns begin, the marginal cost will begin its rise.

Explicit costs

Monetary payment for resources that the firm does not own Ex: Toyota pays steel manufacturers to provide input for vehicle construction

Implicit costs

Opportunity cost of using resources the firm already owns. Ex: Say a retired farmer decides to rent out his farmland. The implicit cost of this decision is the money that could be received by selling the land.

Total Variable Costs (TVC)

Costs that vary with a change in output. Examples: Electricity, wages, materials, transportation services

Reasons for Diseconomies of Scale

1. Control and coordination problems with large scale operations 2. Management Costs and Communication problems with large business 3. Worker alienation - workers may feel alienated and may not work efficiently 4. Shirking, or work avoidance, may be easier in a larger firm.

The Long Run

1. In the long-run, firms can change all inputs being used, including plant capacity 2. In the long-run, firms have enough time to enter and exit the market.

Reasons for Economies of Scale

1. Labor Specialization leads to economies of scale because it makes use of special skills; proficiency is gained as the worker concentrates on one task and time is saved. 2. Managerial Specialization leads to economies of scale because managers can manage more workers with no increased cost, and managers can specialize in their respective area of expertise 3. Efficient Capital leads to economies of scale because high volume production warrants the expensive large scale equipment. 4. Other Factors lead to economies of scale because costs such as design, development, and advertising are spread out over larger quantities.

Economic profit

Accounting profit - implicit costs Economic profit (to summarize) = Revenue - economic cost = Revenue - explicit costs - implicit costs

Law of diminishing Marginal Returns

As successive units of a variable resource (e.g. labor) are added to a fixed resource (e.g. capital or land), the marginal product for each additional unit decreases

Increasing Marginal Returns

As successive units of the variable input are added, marginal product for each additional unit increases.

Total Fixed Costs (TFC)

Costs that do not vary with a change in output. Examples: Rental payments, interest on a firm's debt, capital investment, insurance premiums

Economic costs

Explicit costs + Implicit costs

Long run

Firms have a long window of time to adjust their behavior and therefore can adjust all of their resource usages. Plant capacity, sometimes labor. All inputs are variable. Firms can adjust plant size as well as enter and exit the industry

Short run

Firms have a short window of time to adjust their behavior and therefore can only alter some of their input decisions. Raw materials, energy usage, sometimes labor. Some variable inputs but fixed plant capacity.

Marginal Cost

MC tells a firm how much it will cost to increase output by 1 more unit

MARGINAL COST CURVE

The MC curve always intersects with the AVC and ATC curves at their minimums

Total Cost (TC)

Total Fixed Cost (TFC) + Total Variable Cost (TVC)

Negative Marginal Returns

Total product is decreasing and marginal product is negative

Accounting profit

Total revenue - explicit costs

Marginal product (MP)

the amount that total product changes when labor changes by one unit. It reflects the change in output when one more unit of labor is hired

Normal profits

the minimum payments required to keep the owner's entrepreneurial abilities self employed

Average product (AP)

the output that is produced per unit of labor. Also called labor productivity

Total product (TP)

the total quantity that is produced

Constant Returns to Scale

• Constant returns to scale will occur when ATC is constant over a variety of plant sizes. • When there are constant returns to scale, an increase in inputs will result in a proportionate increase in output. • Explains the flat section of the ATC curve. In other words, a production increase leads to no change in average total cost.

Diseconomies of Scale

• Diseconomies of scale may occur if a firm becomes too large, as illustrated by the rising part of the long run ATC curve. • As the firm expands over time, the expansion may lead to higher average total costs. With diseconomies of scale, an increase in inputs will cause a less than proportionate increase in output. • Explains the upward sloping section of the ATC curve. In other words, a production increase leads to an increase in average total cost

Economies of scale

• Economies of scale refers to the idea that, for a time, larger plant sizes will lead to lower unit costs. There are increasing returns to scale. • An increase in inputs where there are economies of scale will lead to a more than proportionate increase in output. • Explains the downward sloping section of the ATC curve. In other words, a production increase leads to a decrease in average total cost.

Minimum Efficient Scale (MES)

• Lowest level of output at which a firm can minimize long run average costs • Can determine the structure of the industry