Ch 8 Costs the Supply of Goods Incentives and Cooperation Residual Claimants individuals who personally receive the excess of revenues over costs o The have the incentive to increase revenues or reduce costs There are two ways to organize productive activity o 1 Contracting using outside producers for specific tasks o 2 Team Production where employees work together under the supervision of the owner or owner s representative Shirking working at less than the expected rate of productivity which reduces output Principle agent problem the incentive program that occurs when the purchaser of service lacks full information about the circumstances faced by the seller and therefore cannot know how well the seller performs the service o Solve align one s incentives The 3 Types of Business Firms 1 Proprietorship a business firm owned by a single individual o Gets all the profits but accepts all the risk 2 Partnership a business firm owned by two or more individuals o They share the profits and the risk o Can have as many partners as you want 3 Corporation a business firm owned by shareholders o They have the right to the firm s profits but their liability is limited to the amount of their investment Benefits Costs How Many Business Revenue Sole All profits All risk 72 There Are Proprietorship Partnership Share risk Share profits Corporation Liability is limited Taxed twice 9 19 4 13 83 Calculating Economic Costs Profits resources i e 50 000 1 Explicit Costs the payments a firm makes to purchase the goods and services of productive 2 Implicit Costs the opportunity costs associated with the firm s use of resources that it owns i e Foregone interest 20 000 x 10 2 000 you re missing out on by not putting that money in the bank o o o i e Foregone rent 10 000 you re spending instead of selling the space building for more money i e Foregone wages 30 000 you miss out on because you re in college 3 Total Costs TC the costs both explicit and implicit of all of the resources used by the firm 1 o Includes the normal rate of return for the firms equity capital o Explicit Implicit TC 50 000 42 000 92 000 Economic vs Accounting Profit Economic Profit the difference between the firms total revenue and its total costs including both explicit and implicit costs o Econ profit TR Explicit costs Implicit costs i e 0 5M 3M 2M Company is doing as well now as it would under any other conditions not failing i e 1M 5M 3M 3M Business not doing as well as it could should make changes Accounting Profit the sales revenue minus the expenses of the firm does not usually include implicit costs o Accounting profit TR Explicit costs 2M 5M 3M Normal Profit Rate Normal Profit Rate zero economic profit the competitive rate of return on the capital and labor of the owners Zero economic profit does NOT mean the business is failing o Going as well as it possibly could as it would anywhere else o Positive economic profit is rare firms would jump in until it goes back to zero o Negative economic profit means that resources could be used more efficiently Firms would leave until is goes back to zero Losing potential money Short run a time period so short that firm is unable to vary some of its factors of production Long run a time period long enough to allow the firm to vary all of its factors of production Short Run vs Long Run some things cannot change everything can change lots of variability Categories of Costs Total Fixed Costs TFC the sum of the costs that do not vary with output o Fixed costs will remain unchanged as output rises or falls in the short run o o Does not matter if you are producing zero or 1 000 units still have to pay these costs i e Insurance premiums property taxes rent etc Average Fixed Costs AFC Total Fixed Costs divided by the number of units produced o AFC TFC Q o Average fixed costs always declines with output the more the costs are spread among the units 2 Total Variable Costs TVC the sum of those costs that change with output o i e wages raw materials Average Variable Costs AVC total variable costs divided by the number of units produced One can get Total Costs TC by adding together Total Fixed Costs TFC and Total Variable o AVC TVC Q Costs TVC o TC TFC TVC Average Total Costs ATC Total Costs divided by the number of units produced o ATC TC Q or ATC AFC AVC o The ATC curve is U shaped because Average Total Costs will be high for both an under utilized plant AFC is high and an over utilized plant MC is high Will begin decreasing and increases again Marginal Costs MC the change in total costs required to produce an additional unit of output o To increase profits one only produces if the additional revenue marginal revenue from one more unit is greater than the marginal cost of that unit MR MC go MR MC stop On graph intersects ATC AVC at lowest points on curves Output Q TFC TVC TC AFC AVC ATC MC 0 1 2 3 4 5 6 60 60 60 60 60 60 60 60 0 20 30 36 52 70 114 80 90 96 112 130 174 60 30 20 15 12 10 20 15 12 13 14 19 80 45 32 28 26 29 20 10 6 16 18 44 Diminishing Returns and Productions Law of Diminishing Returns as more and more units of a variable resource are applied to a fixed amount of other resources output will eventually increase by smaller and smaller amounts labor o Can increase at some points but will eventually decline again Total Production TP the total output of a good at a given rate of input Marginal Product MP the change in total product associated with each additional unit of Average Product AP the total product divided by the number of variable units labor used to get that total product o AP TP Q 3 Average product increases as long as marginal product is greater than the average opposite is also true o i e Your GPA If you next grade is higher than your average your average will increase the opposite is also true Variable Input Total Product TP Marginal Product MP Average Product AP Employees 0 4 7 11 13 4 3 4 2 4 3 5 3 67 3 25 0 1 2 3 4 The Cost Curves 1 Remember that ATC is U shaped 2 Remember that AFC falls with output 3 AVC is a small part of ATC when output is small and a large part of ATC when output is large 4 MC curve may decrease at first but then rises 5 MC AVC ATC AVC ATC decreases 6 MC AVC ATC AVC ATC increases 4 Output and Costs in the Long Run The Long Run Average Total Cost Curve LRATC shows the minimum …
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