supply: the costs of doing business chapter 8 © 2016 cengage learning. all rights reserved. may not...

Supply: The Costs of Doing BusinessCHAPTER 8

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

The number of resources a firm uses and the amount spent on selling activities depends on how much they contribute to the value of the firm.

In general, the more the firm wants to supply the more resources it must have.

Firms and Production

Output and Resources

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Supply is the quantities of output that sellers are willing and able to offer for sale at every price.

To determine how much to supply at any given price, sellers must know how much it costs to supply each quantity.

An Upward Sloping Supply Curve

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Diminishing Marginal Returns

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

The law of diminishing marginal returns:

When successive equal amounts of a variable resource are combined with a fixed amount of another resource, marginal increases in output that can be attributed to each additional unit of the variable resource will eventually decline.

Diminishing Marginal Returns

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

From Production to Costs

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Average Total Cost

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Average total cost (ATC): the per unit cost derived by dividing total cost by the quantity of output.

Plotting the cost on the vertical axis and quantity of output on the horizontal axis generates the ATC curve.

output totalcost totalATC

Average Total Cost

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Average Total Cost

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Marginal Cost

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Marginal cost (MC): the change in cost caused by a change in output, derived by dividing the change in total cost by the change in the quantity of output.

When marginal cost is greater than average cost, average cost rises -- ATC curve slopes up.

When marginal cost is below ATC, then ATC falls -- ATC curve slopes down.

output ofquantity in change

cost in total changeMC

Marginal Cost

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Average and Marginal Cost

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Definition of Costs

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Total Costs (TC) -- the expenses a business has in supplying goods and/or services.

Total Fixed Costs (TFC) -- payments to resources whose quantities can not be changed during a fixed period of time – the short run.

Total Variable Costs (TVC) -- payments for additional resources used as output increases.

Average Fixed Cost (AFC) -- the total fixed cost divided by total output.

Average Variable Cost (AVC) -- total variable cost divided by total output

Short-Run Average Total Cost (SRATC) -- the total cost of production divided by the total quantity of output produced when at least one resource is fixed

Short vs. Long Run

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

The short run refers to any period of time during which at least one resource cannot be changed. In the long run, everything is variable – nothing is fixed. The most important difference between the short run and the long run is that the law of diminishing marginal returns does not apply when all resources are variable.

Economics of Scale

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Scale means size.

Economies of scale: the decrease in per unit costs as the quantity of production increases and all resources are variable

Diseconomies of scale: the increase in per unit costs as the quantity of production increases and all resources are variable

Constant returns to scale: unit costs remain constant as the quantity of production is increased and all resources are variable

Economies of Scale and Long-Run Cost Curves

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

In the long run, a firm has many sizes to choose from.

The short run requires that scale be fixed— only one or a few resources can be changed.

Long-Run or Planning Period

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Short-Run and Long-Run Average-Cost Curves

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Long-Run Average Total Cost

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Long-run average total cost (LRATC): the lowest-cost combination of resources with which each level of output is produced when all resources are variable.

The long-run average total cost curve gets its shape from economies and diseconomies of scale.

Shape of LRATC

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

If producing each unit of output becomes less costly there are economies of scale.If producing each unit of output becomes more costly there are diseconomies of scale.If unit costs remain constant as output rises there are constant returns to scale.

Long-Run and Short-Run Cost Curves (1)

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Long-Run and Short-Run Cost Curves (2)

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Long-Run and Short-Run Cost Curves (3)

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Minimum Efficient Scale

© 2016 CENGAGE LEARNING. ALL RIGHTS RESERVED. MAY NOT BE COPIED, SCANNED, OR DUPLICATED, IN WHOLE OR IN PART, EXCEPT FOR USE AS PERMITTED IN A LICENSE DISTRIBUTED WITH A CERTAIN PRODUCT OR SERVICE OR OTHERWISE ON A PASSWORD-PROTECTED WEBSITE FOR CLASSROOM USE.

Most industries experience both economies and diseconomies of scale.

The minimum efficient scale (MES) is the minimum point of the long-run average-cost curve; the output level at which the cost per unit of output is the lowest.

The MES varies considerably across industries.