Microeconomics3e-Ch07

Chapter 7: Production, Costs, and Industry Structure

7.1: Explicit and Implicit Costs, and Accounting and Economic Profit

  • Profit Calculation:

    • Profit = Total Revenue – Total Cost

    • Total Revenue = Price × Quantity Sold

  • Costs Definitions:

    • Explicit Costs: Actual payments made out-of-pocket, examples include wages and rent.

    • Implicit Costs: Opportunity costs of using owned resources, includes depreciation of goods and equipment.

  • Types of Profit:

    • Accounting Profit:

      • Difference between total revenue and explicit costs.

      • Accounting Profit = Total Revenue – Explicit Costs

    • Economic Profit:

      • Takes into account both explicit and implicit costs.

      • Economic Profit = Total Revenue – Total Costs (where Total Costs = Explicit Costs + Implicit Costs)

7.2: Production in the Short Run

  • Production Overview:

    • Involves inputs like ingredients, labor, and tools.

  • Factors of Production:

    • Natural Resources, Labor, Capital, Technology, Entrepreneurship.

  • Production Function: Mathematical representation of output based on input usage.

    • Q = f [NR, L, K, t, E]

Inputs

  • Fixed Inputs (K):

    • Factors that cannot be easily changed in the short run.

  • Variable Inputs (L):

    • Factors that can be easily adjusted in the short run.

  • Short-hand Production Function:

    • Q = f [L, K]

Short and Long Run Production

  • Short Run: Time period where at least some production factors are fixed.

  • Long Run: Time period in which all production factors are variable.

  • Example: Lumberjacks using a two-person saw to cut trees, showcasing how labor impacts output in the short run.

Marginal Product

  • Definition:

    • The additional output gained by employing one more worker.

  • Law of Diminishing Marginal Productivity:

    • Additional output produced by increasing labor will eventually decrease.

Short Run Production Function for Trees

  • Overview of Productivity:

    • Increase in labor (lumberjacks) up to a point leads to increased output, after which marginal returns decrease.

7.3: Costs in the Short Run

  • Factor Payments: Cost associated with the use of production factors, including raw materials, rent, wages, etc.

  • Cost Classifications:

    • Variable Costs: Costs that vary with production level (e.g., labor).

    • Fixed Costs: Costs that remain constant regardless of production level (e.g., rent).

    • Total Cost: Sum of fixed and variable costs.

Costs

  • Average Total Cost (ATC):

    • Total cost divided by output quantity.

    • ATC = TC / Q

  • Marginal Cost (MC):

    • Additional cost incurred from producing one more unit.

    • MC = ΔTC / ΔQ

Cost Curves

  • Characteristics:

    • ATC typically U-shaped.

    • Average Variable Cost (AVC) lies below ATC and is usually U-shaped or upward sloping.

    • Marginal Cost (MC) generally shows an upward slope.

Average Profit

  • Calculation:

    • Average Profit = Price – Average Cost

    • When market price > average cost, average profit is positive; if price < average cost, profits are negative.

7.4: Production in the Long Run

  • Long Run Overview:

    • All factors are variable.

    • The production function is represented as Q = f [L, K].

  • Objective:

    • Identify the most efficient production method.

7.5: Costs in the Long Run

  • Cost Characteristics:

    • All costs are variable in the long run.

    • Economies of scale refer to decreasing costs per unit as output increases.

Economies of Scale Example

  • Factory Production Costs:

    • Small factory (1,000 units): Average cost $12/unit.

    • Medium factory (2,000 units): Average cost $8/unit.

    • Large factory (5,000 units): Average cost $4/unit.

  • Conclusion: Economies of scale arise from larger production sizes reducing average costs.

Shapes of Long-Run Average Cost Curves

  • Curves:

    • Long-run average cost (LRAC) curve reflects lowest possible cost over varying quantities.

    • Short-run average cost (SRAC) curves show short-term totals including fixed and variable costs.

Ranges on the Long-Run Average Cost Curve

  • Types of Scale Returns:

    • Constant returns to scale: Average cost stays the same despite increased input.

    • Diseconomies of scale: Average cost increases as total output increases.

The Size and Number of Firms in an Industry

  • Industry Implications:

    • The shape of the long-run average cost curve affects number and size of firms in an industry.

The LRAC Curve and Competitive Output Levels

  • Graph Analysis:

    • Low-cost firms produce at minimum LRAC output levels, while variations allow competition among firms producing at the flat sections of the LRAC curve.