Microeconomics Module 11
The division of time into the short and long run
Reveals two types of cost: variable cost and fixed cost
Total cost
The cost of all the inputs a firm uses in production. Total cost=fixed cost and variable cost
Total cost: def, symbol, and equation
The cost of all the inputs used b a firm, or fixed cost plus variable cost. TC, TC=FC+VC
Common misconceptions to avoid
1. A technology in economies refers to the process of turning inputs into outputs 2. "Increasing average cost" can occur in the short-run (diminishing returns) or in the long-run (diseconomies of scale). The reasons for the two are not the same 3. When calculating marginal product of labor and marginal cost, don't forget about the denominator (bottom line) in the equation; this is the most common error in calculating these 4. The "long run" refers not to a specific period of time, but a conceptual period of time that is sufficiently long to allow all inputs to be altered
1st unit
1st unit is same for marginal cost and average cost
Technological change
A change in the ability of a firm to produce a given level of output with a given quantity of inputs
Cost in the publishing industry
A company that publishes books will not change the number of employees it has based on the quantity of books it publishes in a year. Their employees work on several book simultaneously so the number of employees does not go up or down with the output of books. Salaries and benefits of people in this case are fixed costs. A company that prints books changes the quantity of workers with the quantity of books published. This is a variable cost.
Explicit cost
A cost that involves spending money. Explicit cost of running a firm are relatively easy to identify: just look at what the firm is spend money on. Ex. raw materials, wages, interest on payment, electicity
Long-run average cost curve
A curve that shows the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed. The long run is a sufficiently long period of time that all costs are variable. So, in the long rung, there is no distinction between fixed and variable costs. In the long run, all cost are variable. Total cost equals variable cost, and average total cost equals average variable cost.
Implicit cost
A momentary opportunity cost. The implicit costs are a little harder; finding them involves identifying the resources used in the firm that could have been used for another beneficial purpose. Ex. Forgone salary, economic depreciation, forgone interest
Decomposed average cost equation
ATC=AFC+AVC
Graphing average and marginal cost
At first the two workers bring the price down of the pizza, but as more workers come the more expensive each pizza gets to make. They both make a U shape, but the marginal cost is much steeper by the end
Variable cost
Cost that change as output changes. Ex: labor costs, raw material cost, and cost of electricity
Variable cost: def, symbol, and equation
Costs that change as the firm's level of output changes. VC
Fixed cost: def, symbol, and equation
Costs that remain constant as a firm's level of output changes. FC
Fixed cost
Costs that remain constant as output changes. Ex: lease payment, payment for insurance, and payment for advertising.
Average fixed cost: def, symbol, and equation
Fixed cost divided by the quantity of output produced. AFC=FC/Q
Average fixed cost
Fixed cost that is divided by the quantity of output produced. This cost goes down as less employees are working
Long run costs
In the long run, all of a firm's cost are variable, since the long run is a sufficiently long time to alter the level of any input
Marginal Cost: def, symbol, and equation
Increase in total cost resulting from producing another unit of output. MC=change in TC/change in quantity
Decomposing the Total and Average Costs
We know that total cost can be divided up into fixed and variable costs: TC = FC + VC. If we divide both sides by the level of output (Q), we obtain a useful relationship: TC/Q = FC/Q + VC/Q. The first quantity is average total cost. Then there is average fixed cost and average variable cost
Is the cost zero when quantity is zero
No, the fixed cost will factor in and have the graph start at $800 for this example
Inventory Control at Walmart
One of Wal-Mart's important inputs is its inventory. Wal-Mart invests money to improve management of its inventory, by linking the cash registers with inventory-control computers. Improvements in this technology help Wal-Mart to be more efficient in turning its inputs (inventory, labor, physical store, etc.) into its outputs (sales of products).
Jill's Restaurant inputs
Pizza oven and workers. The pizza oven will be a fixed cost as we assume Jill cannot change (in the short run) the number of ovens she has. The workers will be a variable cost; we will assume Jill can easily change the number of workers she hires
Why might a car company experience of scale
Production might increase at a greater-than-proportional rate as inputs increase. Having more workers can allow specialization. Large firms may be able to purchase inputs at lower prices. But economies of scale will not last forever: eventually managers may have difficulty coordinating huge operations
Chapter 11
Technology, Production, and Costs
Marginal Product of Labor
The additional output a firm produces as a result of hiring one more worker. 1 worker= 200 pizzas, 2 workers= 450 pizzas, 3 workers=550 pizzas, 4 workers=600 pizzas, 5 workers=625 pizzas, 6 workers=640 pizzas
Marginal cost
The change in a firm's total cost from producing one more unit of a good or service. MC=change in total cost/change in quantity
Fixed Cost: Jill's Restaurant
The fixed cost can be found when you look at the cost without producing anything. At zero pizzas, she has $800 for the pizza oven and $0 for workers. So the fixed cost is $800. No matter how many pizzas are made, the pizza oven will cost $800 while the salary will go up $650 every time for the cost of workers (variable cost)
Opportunity cost
The highest valued alternative that must be given up to engage in an activity
Minimum efficient scale
The level of output at which all economies of scale are exhausted
Output and marginal product graph
The output graph will always be increasing, very steep in the beginning but after a while their input becomes smaller and smaller. Marginal product increases very shortly at first and then has a negative curve for the rest. More workers cannot share all the products at once and therefore cannot make as many pizzas per person.
Short run
The period of time during which at least one of a firm's inputs is fixed. Example: A firm might have a long-term lease on a factory that is too costly to get our of.
Long run
The period of time in which a firm can vary all its inputs, adopt new technology, and increase or adopt new technology, and increase or decrease the size of its physical plant
Law of diminishing returns
The principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline. Eventually the pizza workers will start getting in each other's way, etc., because there is only a fixed number of pizza ovens, cash registers, etc.
Technology
The processes a firm uses to turn inputs into outputs of goods and services
Production Function
The relationship between the inputs employed by a firm and the maximum output it can be produced with those inputs. As the number of workers increases, so does that number of pizzas able to be produced.
Constant returns to scale
The situation in which a firm's long-run average costs remain unchanged as it increases output
Dis-economies of scale
The situation in which a firm's long-run average costs rise as the firm increases output
Economies of scale
The situation when a firm's long-run average costs fall as it increases the quantity of output it produces.
Average product of labor
The total output produced by a firm divided by the quantity of workers. It is the average of the marginal products of labor. Ex. 3 workers make 550 pizzas: 555/3=183.333.
Graphing the various cost curves
This results in both ATC and AVC having their U-shaped curves. The MC curve cuts through each at its minimum point, since both ATC and AVC "follow" the MC curve. Also notice that the vertical sum of the AVC and AFC curves is the ATC curve. And because AFC gets smaller, the ATC and AVC curves converge.
Average total cost: def, symbol, and equation
Total cost divided by the quantity of output produced. ATC=TC/Q
Average total cost
Total cost divided by the quantity of output produced. For low levels of production, the average cost falls as the number of pizza rises; at higher levels, the average cost rises as the number of pizza rises. AC=TC/Q. This creates a U-shaped curve
The basic activity of a firm is to
Use inputs (for example: workers, machines, and natural resources) and to produce outputs of goods and services.
Average variable cost: def, symbol, and equation
Variable cost divided by the quantity of output produced. AVC=VC/Q
Average variable cost
Variable cost divided by the quantity of output produced. This cost goes up as more employees are working
Marginal and Total cost effects
When MC is below average total cost, average total cost if falling. When MC is above ATC, ATC is rising
Marginal cost and marginal production
When the marginal product of labor is rising, the marginal cost of output if falling. When the marginal product of labor is falling, the marginal cost of output is rising. The marginal cost of output falls and then rises, forming a U shape, because the marginal product of labor rises and then falls. MP= slope of production function quantity, MC=Slope of TC
Marginal vs Average Product
You can think of this as GPAs. Marginal GPAs are semester grades while Average GPAs are based on everything divided by the number of semesters. They will both start at the same point because there is only one piece of data to base it on. From then on marginal can be whatever it wants while average is based on past and present.
