Chapter 6ProductionThe Production FunctionShort-Run versus Long-Run DecisionsProduction in the Short-RunTotal and Marginal ProductMarginal Returns To LaborThinking About CostsExplicit vs. Implicit CostsCosts in the Short RunTotal Costs in the Short RunTotal Cost CurvesAverage CostsMarginal CostAverage And Marginal CostsSlide 16Production And Cost in the Long RunSlide 18Average Cost And Plant SizeGraphing the LRATC CurveThe Shape of LRATCSlide 22The Shape Of LRATCThe Urge to MergeSlide 25Appendix: Isoquant AnalysisAppendix: An Isoquant MapAppendix: MRTSAppendix: Isocost LinesSlide 30Appendix: The Least-Cost Input CombinationSlide 32Chapter 6Production and CostECONOMICS: Principles and Applications, 4e HALL & LIEBERMAN, © 2008 Thomson South-Western2Production•Business firm – an organization–Owned and operated by private individuals–Specializes in production•Production–Process of combining inputs to make goods and services•Technology –Method of combining inputs to produce goods or services3The Production Function•Indicates the maximum amount of output a firm can produce over some period of time from each combination of inputs•Figure 1 The Firm’s Production FunctionDifferentCombinations ofInputsDifferentQuantitiesof OutputProductionFunction4Short-Run versus Long-Run Decisions•Long run–A time horizon long enough for a firm to vary all of its inputs–Variable inputs - can be adjusted up or down as the quantity of output changes•Short run–A time period during which at least one of the firm’s inputs is fixed–Fixed inputs - cannot be adjusted as output changes in the short run5Production in the Short-Run•Total product–Maximum quantity of output that can be produced from a given combination of inputs•Marginal product of labor: MPL=ΔQ/ΔL–Additional output produced when one more worker is hired6Total and Marginal Product3090130160184196Total ProductQ from hiring fourth worker = 30Q from hiring third worker = 40Q from hiring second worker = 60Q from hiring first worker = 30increasing marginal returnsdiminishing marginal returnsUnits of OutputNumber of Workers623451•Figure 2 Total and Marginal Product7Marginal Returns To Labor•Increasing marginal returns to labor–MPL increases as more labor is hired•Diminishing marginal returns to labor–MPL decreases as more labor is hired•Law of Diminishing Marginal Returns –As more and more of any input is added to a fixed amount of other inputs, its marginal product will eventually decline8Thinking About Costs•Total cost–The opportunity cost of the owners - everything they must give up in order to produce that amount of output•Sunk cost–A cost that has been paid or must be paid, regardless of any future action being considered–Should not be considered when making decisions9Explicit vs. Implicit Costs•Explicit cost–Money actually paid out for the use of inputs•Implicit cost–The cost of inputs for which there is no direct money payment10Costs in the Short Run•Fixed costs –Costs of a firm’s fixed inputs–Remain constant as output changes•Variable costs –Costs of a firm’s variable inputs–Change with output11Total Costs in the Short Run•Total fixed cost (TFC)–The cost of all inputs that are fixed in the short run•Total variable cost (TVC)–The cost of all variable inputs used in production•Total cost (TC=TFC+TVC)–The costs of all inputs—fixed and variable12Total Cost CurvesTC0Dollars135195255315375$43530 90 130 160Units of Output184TFCTFCTVC•Figure 3 The Firm’s Total Cost Curves13Average Costs•Average fixed cost (AFC=TFC/Q)–Total fixed cost divided by the quantity of output produced•Average variable cost (AVC=TVC/Q)–Cost of the variable inputs per unit of output•Average total cost (ATC=TC/Q)–Total cost per unit of output14Marginal Cost•Marginal Cost (MC)–Increase in total cost from producing one more unit or outputΔQΔTCMC •MC curve is U-shaped –When MPL rises, MC falls –When MPL falls, MC rises. –MPL rises and then falls, MC will fall and then rise.15Average And Marginal CostsMCAVCATCAFCUnits of OutputDollars$432130 90 130 160 1960•Figure 4 Average And Marginal Costs16Average And Marginal Costs•At low levels of output–MC - below the AVC and ATC curves–AVC and ATC slope downward•At higher levels of output–MC - above the AVC and ATC curves–AVC and ATC slope upward•U-shaped curves•MC curve will intersect the minimum points of the AVC and ATC curves17Production And Cost in the Long Run•All inputs and all costs are variable•Least Cost Rule–To produce any given level of output, the firm will choose the input mix with the lowest cost•Long-run total cost (LRTC)–The cost of producing each quantity of output when the least-cost input mix is chosen in the long run18Production And Cost in the Long Run•Long-run average total cost (LRATC)–The cost per unit of output•in the long run•all inputs are variableQLRTCLRATC •LRTC ≤ TC•LRATC ≤ ATC19Average Cost And Plant Size•Plant - Collection of fixed inputs at a firm’s disposal•Short run–Cannot change the plant size–Move along ATC curve •Long run–Choose among ATC curves–Can change the plant size –Produce at lowest possible ATC20Graphing the LRATC CurveLRATCATC1Use 0 automated linesATC3ATC0CBAATC2DE175 196184Dollars1.002.003.00$4.00Units of Output30 90 130 160 250 3000Use 1 automated linesUse 2 automated linesUse 3 automated lines•Figure 5 Long-Run Average Total Cost21The Shape of LRATC•Economies of scale - LRATC decreases as output increases–LRATC curve slopes downward•More likely to occur at lower levels of output•Spreading costs of Lumpy inputs•Diseconomies of scale - LRATC increases as output increases–LRATC curve slopes upward •More likely at higher output levels22The Shape of LRATC•Constant returns to scale - LRATC is unchanged as output increases–LRATC curve is flat•U-shape of LRATC curve–Economies of scale at relatively low levels of output–Constant returns to scale at some intermediate levels of output–Diseconomies of scale at relatively high levels of output23The Shape Of LRATCUnits of OutputLRATCEconomies of Scale Constant Returns to ScaleDiseconomies of Scale0Dollars1.002.003.00$4.00130 184•Figure 6 The Shape Of LRATC24The Urge to Merge•Minimum efficient scale (MES)–The lowest output level at the minimum cost per unit in the long run•Mergers–Significant, unexploited
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