I. Introduction
A. The last two chapters were an in-depth
exploration of demand.
B. This chapter will explore costs, the key
determinate of supply.
II. Understanding costs
A. Costs
are the dollars paid for the factors of production.
B. Opportunity
cost is the value of the best alternate use, e.g., the
opportunity cost of labor is the value that
could have been received
from using capital.
C. Explicit costs versus implicit
costs
1. Explicit
costs require an out-of-pocket expenditure, e.g., wages,
materials, and overhead.
2.
Implicit costs do not require an outlay, e.g.,
rent a company could receive by renting a facility used in the business
and uncompensated efforts by family members in a
family-operated business.
Include a normal return on investment, which is the minimum amount
required to keep resources employed at their
current use.
D. Accounting profits versus economic
profits
1. Accounting
profit is revenue minus explicit costs.
2. Economic
profit is revenue minus explicit plus implicit costs.
3. In the
long run competition causes economic profit to be zero.
E. Short run versus long run costs
1. In the short
run costs are both fixed and variable.
a.
Fixed costs do not vary with production, e.g.,
plant and equipment, property taxes, most overhead, etc.
b.
Variable costs vary directly with
production, e.g., labor and materials
c.
Marginal cost is the change in total costs
which results from making one more unit.
2. In the long
run all costs are variable as fixed costs may increase.
F. Diminishing returns:
1. Adding
a variable resource (labor) to a fixed resource (capital) will increase
production for a while.
2. At some
point the rate of
increase declines and eventually becomes negative.
3. Diminishing returns affect both
the production of labor and cost of production.
4. Example: When eating at my
mother's house I would say using three people to do the dishes didn't make sense
because the
third person just got in the way. She agreed so me and my sisters did the
dishes.
5. The importance of diminishing
returns is explored by
Diminishing Returns
from Dr.
William King of Drexel University.
5.
Diminishing returns - Wikipedia
has additional information.
III. Understanding Labor Productivity
|
Total product of labor (TPL) measures total
production occurring as more workers are added to a production process
containing fixed resources.
Marginal product of labor (MPL)
measures the change in the TPL which occurs as more workers are
added to a production process containing fixed resources.
Average product of labor (APL)
measures the average production of all workers as additional workers are
added to a production process containing fixed resources.
Note: MPL should be plotted at the mid-point on the
x-axis.
|
Number of
Workers |
Total Product
of Labor (TPL) |
Marginal
Product of Labor (MPL) |
Average
Product |
 |
| 0 |
0 |
0 |
0 |
| 1 |
6 |
6 |
6 |
| 2 |
14 |
8 |
7 |
| 3 |
24 |
10 |
8 |
| 4 |
32 |
8 |
8 |
| 5 |
35 |
3 |
7 |
| 6 |
35 |
0 |
5.83 |
| 7 |
28 |
-7 |
4 |
IV. Determining Production Costs Note:
Units
Produced
(1) |
Total
Fixed
Costs
(2) |
Total Variable
Costs
(3) |
Total
Costs
(2+3) |
Marginal
Costs is change in TC
per unit |
Average Fixed
Costs
(2/1) |
Average
Variable Costs
(3/1) |
Average Total
Costs (2+3)/1 |
| 0 |
500 |
0 |
500 |
NA |
|
|
|
| 1 |
500 |
500 |
1000 |
500 |
500 |
500 |
1000 |
| 2 |
500 |
900 |
1400 |
400 |
250 |
450 |
700 |
| 3 |
500 |
1200 |
1700 |
300 |
167 |
400 |
567 |
| 4 |
500 |
1500 |
2000 |
300 |
125 |
375 |
500 |
| 5 |
500 |
1900 |
2400 |
400 |
100 |
380 |
480 |
| 6 |
500 |
2400 |
2900 |
500 |
83 |
400 |
483 |
| 7 |
500 |
3000 |
3500 |
600 |
71 |
429 |
500 |
V. Graphing Production Costs
VI. Productivity affects costs
 |
Note that AV is the mirror
image of AP and MC is the mirror image of MP.
Analysis:
At low quantities MP is above AP so AP is rising. As MP starts
to fall AP flattens but continues to rise because MP is still
higher. When MP drops below AP, AP immediately begins to decrease indicating the intersection must be
AP's highest point.
At low quantities MC is below AVC so AVC is falling. As MC starts to rise
AVC flattens but continues to decrease because MC is
still lower. When MC rises above AVC,
AVC immediately begins to rise indicating the
intersection must be AVC's lowest point.
|
about the author Walter
Antoniotti
and 21st
Century Learning Products |
|
|
VII. Total variable costs are not a straight line but an
S-shaped curve.
VIII. Economies and diseconomies of scale
| Start-up costs cause the
curve to rise quickly at low levels of production. Examples
include learning curve activities and spoilage.
Economies of scale make production very
efficient causing the curve to flatten out over a
considerable range of production. Examples include labor/management
specialization, volume discounts, and use of
by-product.
Diseconomies of scale cause production to be
inefficient and result in the curve rising sharply as maximum capacity is
approached. Examples include
Bureaucracy and diminishing returns. Japanese
flexible production techniques enhance economies of scale and stretched
out the low point on the AVC line. These techniques have been adopted by
manufacturers around the world. |
 |
| For more
information on the economies and diseconomies of scale read
Economies of scale and
Dis-economies of scale
from tutor2u.
|
IX.
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