Chapter 11 Microeconomics

Graphing Cost Curves

We have seen that we calulate average total cost by dividing toal cost by the quantity of output produced We can calculate average fixed cost by dividing fixed cost by the quantity of ouptut produced We can calculate average variable cost by dividing variable cost by the quantity of output produced ATC= AFC + AVC AVC= VC/Q AFC= FC/ Q ATC= TC/Q

Conclusion

Seen the important relationship between a firm's level of production and its costs This information is vital to all firms as they attempt to decide the optimal level of production and the optimal prices to charge for their products

Implicit Costs vs Explicit Costs

Opportunity cost- highest-valued alternative that must be given up to engage in an activity Costs are either implicit or explicit When a firm spends money, it incurs an explicit cost When a firm experiences a nonmonetary opportunity cost, it incurs an implicit cost Economic depreciation- difference between what somone paid for capital at the beginning of the year and what you recieve if you sold the capital at the end of the year The rules of accounting generally require that only explicit costs be used for purposes of keeping the company's financial recors and for paying taxes Explicit costs are sometimes called accounting costs Economic costs include both accounting costs and implicit costs

Firms may experience economies of scale for a number of reasons

1. As in the case of automobile production, the firm's technology may make it possible to increas production with a smaller proportional increase in at least one input. 2. Both workers and managers can become more specialized, enabling them to become more productive, as output expands 3. Large firms may be able to purchase inputs at lower costs than smaller competitors. Their bargaining power with their suppliers increased, and their average costs fell 4. As a firm expands, it may be able to borrow money at a lower interest rate, therby lowering its costs

What to know about graphs

1. The marginal cost, average total cost, and average variable cost curves are all U shaped, and the marginal cost curve intersects both the average variable cost curve and the average total cost curve at their minimum points When marginal cost is below either average variable cost or average total cost, it causes them to decrease When marginal cost is above average variable cost or average total cost, it causes them to increase Therefore, when marginal cost equals average variable cost or average total cost, they must be at their minimum points 2. As output increases, average fixed cost gets smaller and smaller In calculating average fixed cost, we are dividing osmething that gets larger and larger (output) into something that remains constant (fixed) Firms often refer to this process of lowering average fixed cost by selling more output as "spreading the overhead" (where overhead refers to fixed cost) 3. As output increase, the difference between average total cost and average variable cost decreases. The difference between average total cost and average variable cost is average fixed cost, which gets smaller as output increases

A First Look at the Relationship between Production and Cost

Average total cost- always equal to its total cost divided by the quantity of output produced As production increases from low levels, average total cost fallws Average total cost then rises at higher levels of production

Graphing Production

Because of specialization and the division of labor, ouput at first increases at an increasing rate, with each additional worker hired causing production to increase by a larger amount than did the hiring of the previous worker -but after the second worker has been hired, hiring more workers while keeping the quantity of ovens constant results in diminishing returns When the point of diminishing returns is reached, production increases at a decreasing rate Each additional woeker hired after the sceond workers causes production to increase by a smaller amount than did the hiring of the previous woeker

Economies of Scale

Short-run average cost curves represent the costs a firm faces when some input, such as the quantity of machines it uses, is fixed The long-run average cost curve shows the lowest cost at which a firm is able to produce a given quantity of output in the lng run, when no inputs are fixed A firm may experience economics of scale, which means the firm's long-run average cost falls as it increases the quantity of output it produces Managers can use long-run average cost curves for planning because they show the effect on cost of expanding output Economies of scale do not continue indefintiely as the firm increases its ouptut The long-run average cost curve in most industries has a flat segment htat often stretches over a substantail range of output Constant returns of scales- the situation in which a firm's long-run average costs remain unchanged as it increases output As these firms increase their output, they increase their input proportionaly minimum efficient scale- the level of output at which all economies of scale are exhausted Firms that produce at less than min. efficient scale may have difficulty surviving because they will be producing output at higher cost than competitors Diseconomies of scale- the situation in which a firm's long0run average cost rises as the firm increases output Over time, most firms in an industry will build factories or stores that are at least as large as the minimum efficient scale but not so large that disconomies of scale occur Firms often do not know the exact shape of their long-run average cost curves -as a result, they may mistakenly build factories or stores that are either too large or too small

The Relationship between Short-Run Producton and Short-Run Cost

Technology determines the values of the marginal product of labor and the average product of labor -in turn, the marginal and average products of labor affect the firm's costs We are assuming that the time period is too short for the firm to changes its technology or the size of its physical plant The U shape of the average total cost curve is determined by the shape of the curve that shows the relationship between marginal cost and the level of production

Technology: An Economic Definition

The basic activity of a firm is to use inputs (workers, machines, natural resources) to produce outputs of goods and servics A firm's technology is the processes it uses to turn inputs into outputs of goods and services in everyday langauge, technology usualyl refers only to the development of new products -in the economic sense, a firm's technology depends on many factors Whenever a firm experiences positive technological change, it is able to produce more output using the same inputs or the same output using fewer inputs Positive technological change can come from many sources It is also possible for a firm to experience negative technological change

Costs in the Long Run

The distinction between fixed cost and variable cost applies to the short run but not to the long run In the long run, all costs are variable; there are no fixed costs in the long run In the long run, total cost equals variable cost, and average total cost equals average variable cost Managers of successful firms simultaneously consier how they can most profitabl run their current store, factory, or office, and also whether in the long run they would be more profitable if they became larger or smaller

The Relationship between Marginal Product and Average Product

The marginal product of laor tells us how much total outut changes as the quantity of workers hired changes The average product of labor is the average of the marignal products of labor Whenver the marginal product of labor is greater than the average product of labor, the average prodcut of labor must be increasing Whenever the marginal product of labor is less than the average product of labor, the average product of labor must be decreasing The marginal product of labor equals the average product of albor at the quantity of workers for which the average product of labor is at at its maximum

The Production Function

The relationship between the inputs employed by a firm and the maximum output it can produce with those inputs Because a firm's technology is the processes it uses to turn inputs into ouput, the production function represents the firm's technology

The Difference between Fixed Costs and Variable Costs

Total cost- cost of all the inputs a firm uses in production The costs of the fixed inputes= fixed costs cost of the variable inputs=variable costs variable costs- costs that change as output changes fixed costs- costs that remain constant as output changes A typical firm's variable costs include its labor costs, raw material costs, and costs of electricity and other utilities Typical fixed costs include lease payments for factory or retail space, payments for fire insurance, and payments for online and television advertising All of a firm's costs are either fixed or variable TC= FC + VC

The Short Run and the Long Run in Economics

When firms analyze the relationship between their level of production and their costs, they separate the time period involved into the short run and long run In the short run, at least one of the firm's inuts is fixed -in particular, in the short run, the firm's technology and the size of its physical plant are both fixed, while some other inputs, including the number of workers the firm hires, are variable In the long run, the firm is able to vary all its inputs and can adopt new technology and increase or decrease the size of its physical plant The actual length of calendar time before the short run becomes the long run differs from firm to firm

Why are the marginal and average cost curves U shaped?

When the marginal product of labor is rising, the marginal cost of output is falling When the marginal product of labor is falling, the marginal cost of output is rising As long as the additional otput from each new worker is rising, the marginal cost of that output is falling When the additional ouput from each new worker is falling, the marginal cost of the output is rising The marginal cost of ouput falls and then rises- forming a U shape- because the marginal product of labor rises and then falls The relationship between marginal cost and average total cost follows the usual relationship between marginal and average values As long as marginal cost is below average total cost, average total cost falls When marginal cost is above average total cost, average total cost rises Marginal cost equals average total cost when average total cost is at its lowest point -therefore, the average ottal cost curve has a U shape because the marginal cost curve has a U shape

The Law of Diminishing Returns

adding more of a variable input to the same amount of fixed input wil leventually cause the marginal product of the variable input to decline When the marginal product is negative, the level of output declines No firm would in reality hire so many owkers as to experience a negative marginal product of labor and falling total ouput

The Marginal Product of Labor and the Average Product of Labor

marginal product of labr- the additional output a firm produces as a result of hiring one more owrker increase in marginal product results from the division of labor and from specialization By dividing the taks to be performed, it reduces the time workerslose movign from one activity to the next -also allows them to become more specialized at their tasks

Marginal Cost

optimal decisions are made at the margin Consumers, firms, and government offiicals usually make decisions about doing a little more or a litle ess Marginal cost- the change in a firm's total cost from producing one more unit of a good or service Can calculate marginal cost for a particular increase in output by dividing the change in toaal cost by the change in ouput MC= change in total cost change in quantity