Professional Documents
Culture Documents
Costs of Production 2
Costs of Production 2
Production
The Meaning of Costs
• Opportunity costs
– meaning of opportunity cost
– examples
• Measuring a firm’s opportunity costs
– factors not owned by the firm: explicit costs
– factors already owned by the firm: implicit
costs
– irrelevance of:
• historic costs
• replacement costs
Production in the Short run
• Production functions
– factors of production
• labour
• land and raw materials
• capital
• entrepreneurship
1 3
2 10
30 3 24
4 36
5 40
6 42
7 42
20 8 40
10
0
0 1 2 3 4 5 6 7 8
Number of farm workers
Wheat production per year from a particular farm
Number of
40 workers TPP
0 0
Tonnes of wheat produced per year
1 3
2 10
30 3 24
4 36
5 40
6 42
7 42
20 8 40
10
0
0 1 2 3 4 5 6 7 8
Number of farm workers
Wheat production per year from a particular farm
d
40
TPP
Tonnes of wheat produced per year
30 Maximum output
Diminishing returns
set in here
20
b
10
0
0 1 2 3 4 5 6 7 8
Number of farm workers
Wheat production per year from a particular farm
40
20
10
∆TPP = 7
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14 ∆L = 1
Tonnes of wheat per year
12
10
8
MPP = ∆TPP / ∆L = 7
6
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
Wheat production per year from a particular farm
40
20
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
Tonnes of wheat per year
12
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
Wheat production per year from a particular farm
40
20
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
Tonnes of wheat per year
12 APP = TPP / L
10
4 APP
2
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
Wheat production per year from a particular farm
40
20 b
Diminishing returns
10 set in here
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
b
Tonnes of wheat per year
12
10
4 APP
2
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
Wheat production per year from a particular farm
d
40
20 Maximum
b
output
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
b
Tonnes of wheat per year
12
10
4 APP
2
0 d Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
Wheat production per year from a particular farm
d
40
Slope = TPP / L c
20
b
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
b
Tonnes of wheat per year
12
10
c
8
4 APP
2
0 d Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
Costs in the Short run
0 12
1 12
80 2 12
3 12
4 12
60 5 12
6 12
7 12
40
20
0
0 1 2 3 4 5 6 7 8
Total costs for firm X
Output TFC
100 (Q) (£)
0 12
1 12
80 2 12
3 12
4 12
60 5 12
6 12
7 12
40
20
TFC
0
0 1 2 3 4 5 6 7 8
Total costs for firm X
Output TFC TVC
100 (Q) (£) (£)
0 12 0
1 12 10
80 2 12 16
3 12 21
4 12 28
60 5 12 40
6 12 60
7 12 91
40
20
TFC
0
0 1 2 3 4 5 6 7 8
Total costs for firm X
Output TFC TVC
100 (Q) (£) (£)
0 12 0 TVC
1 12 10
80 2 12 16
3 12 21
4 12 28
60 5 12 40
6 12 60
7 12 91
40
20
TFC
0
0 1 2 3 4 5 6 7 8
Total costs for firm X
Output TFC TVC TC
100 (Q) (£) (£) (£)
0 12 0 12 TVC
1 12 10 22
80 2 12 16 28
3 12 21 33
4 12 28 40
60 5 12 40 52
6 12 60 72
7 12 91 103
40
20
TFC
0
0 1 2 3 4 5 6 7 8
Total costs for firm X
Output TFC TVC TC
100 (Q) (£) (£) (£) TC
0 12 0 12 TVC
1 12 10 22
80 2 12 16 28
3 12 21 33
4 12 28 40
60 5 12 40 52
6 12 60 72
7 12 91 103
40
20
TFC
0
0 1 2 3 4 5 6 7 8
Total costs for firm X
100 TC
TVC
80
Diminishing marginal
60
returns set in here
40
20
TFC
0
0 1 2 3 4 5 6 7 8
Costs in the Short run
• Marginal cost
Diminishing marginal
returns set in here
Costs (£)
Output (Q)
Costs in the Short run
• Marginal cost
Output (Q)
Costs in the Short run
• Average cost
AVC
Costs (£)
x
AFC
Output (Q)
Production in the Long run
• Economies of scale
– specialisation & division of labour
– indivisibilities
– container principle
– greater efficiency of large machines
– by-products
– multi-stage production
– organisational & administrative economies
– financial economies
• Economies of scope
Production in the Long run
• Diseconomies of scale
– managerial diseconomies
– effects of workers and industrial relations
– risks of interdependencies
• External economies of scale
• External diseconomies of scale
• Location
– balancing the distance from suppliers and
consumers
– importance of transport costs
Production in the Long run
Economies of Scale
Costs
LRAC
O Output
Alternative long-run average cost curves
LRAC
Diseconomies of Scale
Costs
O Output
Alternative long-run average cost curves
Constant costs
Costs
LRAC
O Output
A typical long-run average cost curve
LRAC
Costs
O Output
A typical long-run average cost curve
O Output
Costs in the Long run
Economies of Scale
Costs
LRAC
LRMC
O Output
Long-run average and marginal costs
LRMC
LRAC
Diseconomies of Scale
Costs
O Output
Long-run average and marginal costs
Constant costs
Costs
LRAC = LRMC
O Output
Long-run average and marginal costs
LRMC
Initial economies of scale,
then diseconomies of scale
LRAC
Costs
O Output
Costs in the Long run
5 factories
Costs
1 factory
2 factories
3 factories4 factories
O
Output
Deriving long-run average cost curves: factories of fixed size
LRAC
Costs
O
Output
Deriving a long-run average cost curve: choice of factory size
Costs
Examples of short-run
average cost curves
O
Output
Deriving a long-run average cost curve: choice of factory size
LRAC
Costs
O
Output
Costs in the Long run