Chapter 9
Businesses and the Costs
of Production
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Economic Costs LO 1
•Economic cost
•The payment that must be made to obtain and
retain the services of a resource
•Explicit costs
• Monetary outlay
•Implicit costs
• Opportunity cost of using self-owned
resources
• Includes a normal profit
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Accounting Profit and Normal
Profit LO 1
𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐢𝐧𝐠 𝐩𝐫𝐨𝐟𝐢𝐭 = Revenue − explicit costs
𝐄𝐜𝐨𝐧𝐨𝐦𝐢𝐜 𝐩𝐫𝐨𝐟𝐢𝐭
= Accounting pro@it − implicit costs
Economic profit (to summarize)
= Revenue − economic costs
= Revenue − explicit costs − implicit costs
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Economic Profit versus
Accounting Profit LO 1
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Short Run and Long Run LO 2
Short run
• Some variable inputs
• Fixed plant
Long run
• All inputs are variable
• Firms can adjust plant size as well as
enter and exit industry
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Short Run Production Relationships
LO 2
Total product (TP)
Marginal product (MP)
change in total product
Marginal product =
change in labor input
Average product (AP)
total product
Average product =
units of labor
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Law of Diminishing Returns 1 of 3
LO 2
•Law of diminishing returns
• Resources are of equal quality
• Technology is fixed
• Variable resources are added to fixed
resources
• At some point, marginal product will fall
•Rationale
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The Law of Diminishing Returns 2 of 3
LO 2
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The Law of Diminishing Returns 3 of 3
LO 2
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Short Run Production Costs LO 3
•Fixed costs (TFC)
• Costs that do not vary with output
•Variable costs (TVC)
• Costs that do vary with output
•Total cost (TC)
• Sum of TFC and TVC
• TC = TFC + TVC
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Short Run Cost Curves LO 3
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Per-Unit, or Average, Costs LO 3
!"#
Average fixed cost: AFC =
$
!%#
Average variable cost: AVC =
$
!#
Average total cost: ATC =
$
∆!#
Marginal cost: MC =
∆$
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Short Run Cost Schedules LO 3
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Average Cost Curves LO 3
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Marginal Cost LO 3
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Marginal Cost
and Marginal
Product
LO 3
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Long Run Production Costs LO 4
The firm can change all input amounts,
including plant size
All costs are variable in the long run
Long run ATC
• Now consider costs in terms of average
total costs
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Firm Size and Costs LO 4
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The Long Run Cost Curve LO 4
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Economies of Scale LO 4
•Economies of scale
• Labor specialization
• Managerial specialization
• Efficient capital
• Other factors
•Constant returns to scale
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Diseconomies of Scale LO 4
•Diseconomies of scale
• Control and coordination problems
• Communication problems
• Worker alienation
• Shirking
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Minimum Efficient Scale LO 4
•Minimum efficient scale (MES)
• Lowest level of output at which long run
average costs are minimized
• Can determine the structure of the
industry
•Natural monopoly
• Long run costs are minimized when only
one firm produces the product
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MES and Industry Structure 1 of 3
LO 4
Economies Constant returns Diseconomies
of scale to scale of scale
Average total costs
Long-run
ATC
q1 q2
Output
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MES and Industry Structure 2 of 3
LO 4
Economies Diseconomies
of scale of scale
Average total costs
Long-run
ATC
Output
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MES and Industry Structure 3 of 3
LO 4
Economies Diseconomies
of scale of scale
Average total costs
Long-run
ATC
Output
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Applications and Illustrations LO 5
Rising gasoline prices
Successful start-up firms
Verson stamping machine
The daily newspaper
Aircraft and concrete plants
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3D Printers and Mass
Customization
First industrial revolution began in 1700s
Mass production led to mass affordability
Second industrial revolution began late
1800s
Mass sales were necessary to spread R&D
costs
Third industrial revolution beginning now
Affordable mass customization with zero
transportation costs
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