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Chapter 8Chapter 8Chapter 8Chapter 8
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The Meaning of CostsThe Meaning of CostsThe Meaning of CostsThe Meaning of Costs
• Opportunity costsOpportunity costs
• Measuring a firm’s opportunity costsMeasuring a firm’s opportunity costs
– factors not owned by the firm: explicit costsfactors not owned by the firm: explicit costs
– factors already owned by the firm: implicit factors already owned by the firm: implicit costscosts
– irrelevance of historic costs and replacement irrelevance of historic costs and replacement costscosts
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Production in the Short runProduction in the Short runProduction in the Short runProduction in the Short run
• Production functionsProduction functions
• Long-run and short-run production: Long-run and short-run production: – fixed and variable factorsfixed and variable factors
• The law of diminishing returnsThe law of diminishing returns
• The short-run production function:The short-run production function:– total physical product (total physical product (TPPTPP))
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Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
0
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0 1 2 3 4 5 6 7 8
Number of farm workers
To
nne
s o
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eat
pro
du
ced
pe
r ye
ar
Number of workers
012345678
TPP 0 310243640424240
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To
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Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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0 1 2 3 4 5 6 7 8
Number of farm workers
To
nne
s o
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eat
pro
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ar TPP
a
b
Diminishing returnsset in here
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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To
nne
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a
b
d
Maximum output
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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Production in the Short runProduction in the Short runProduction in the Short runProduction in the Short run
• Production functionsProduction functions
• Long-run and short-run production: Long-run and short-run production: – fixed and variable factorsfixed and variable factors
• The law of diminishing returnsThe law of diminishing returns
• The short-run production function:The short-run production function:– total physical product (total physical product (TPPTPP))
– average physical product (average physical product (APPAPP))
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Production in the Short runProduction in the Short runProduction in the Short runProduction in the Short run
• Production functionsProduction functions
• Long-run and short-run production: Long-run and short-run production: – fixed and variable factorsfixed and variable factors
• The law of diminishing returnsThe law of diminishing returns
• The short-run production function:The short-run production function:– total physical product (total physical product (TPPTPP))
– average physical product (average physical product (APPAPP))
– marginal physical product (marginal physical product (MPPMPP))
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Production in the Short runProduction in the Short runProduction in the Short runProduction in the Short run
• Production functionsProduction functions
• Long-run and short-run production: Long-run and short-run production: – fixed and variable factorsfixed and variable factors
• The law of diminishing returnsThe law of diminishing returns
• The short-run production function:The short-run production function:– total physical product (total physical product (TPPTPP))
– average physical product (average physical product (APPAPP))
– marginal physical product (marginal physical product (MPPMPP))
– the graphical relationship between the graphical relationship between TPPTPP, , APPAPP and and MPPMPP
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0
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0 1 2 3 4 5 6 7 8
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
Number offarm workers (L)
Ton
nes
of w
heat
per
yea
r
TPP
-2
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of w
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Number offarm workers (L)
TPP = 7
L = 1
MPP = TPP / L = 7
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MPP
Number offarm workers (L)
Number offarm workers (L)
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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APP
MPP
APP = TPP / L
Number offarm workers (L)
Number offarm workers (L)
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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APP
MPP
b
Diminishing returnsset in here
Number offarm workers (L)
Number offarm workers (L)
b
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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-2
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APP
MPP
b
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d
Number offarm workers (L)
Number offarm workers (L)
Maximumoutputb
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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Number offarm workers (L)
Number offarm workers (L)
Slope = TPP / L= APP
c
c
Wheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farmWheat production per year from a particular farm
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Costs in the Short runCosts in the Short runCosts in the Short runCosts in the Short run
• Costs and inputsCosts and inputs
– costs and the productivity of factorscosts and the productivity of factors
– costs and the price of factorscosts and the price of factors
• Fixed costs and variable costsFixed costs and variable costs
• Total costsTotal costs
– total fixed cost (total fixed cost (TFCTFC))
– total variable cost (total variable cost (TVCTVC))
– total cost (total cost (TC = TFC + TVCTC = TFC + TVC))
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Total costs for firm XTotal costs for firm XTotal costs for firm XTotal costs for firm X
0
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TFC
Output(Q)
01234567
TFC(£)
1212121212121212
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0
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TVC
TFC
Output(Q)
01234567
TFC(£)
1212121212121212
TVC(£)
010162128406091
Total costs for firm XTotal costs for firm XTotal costs for firm XTotal costs for firm X
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0
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TC
TVC
TFC
Output(Q)
01234567
TFC(£)
1212121212121212
TVC(£)
010162128406091
TC(£)
12222833405272
103
Total costs for firm XTotal costs for firm XTotal costs for firm XTotal costs for firm X
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0
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TVC
TFC
Diminishing marginal returnsset in here
TC
Total costs for firm XTotal costs for firm XTotal costs for firm XTotal costs for firm X
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Costs in the Short runCosts in the Short runCosts in the Short runCosts in the Short run
• Marginal costMarginal cost– marginal cost (marginal cost (MCMC) and the law of diminishing ) and the law of diminishing
returnsreturns– the relationship between the marginal and the relationship between the marginal and
total cost curvestotal cost curves
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Marginal costMarginal costMarginal costMarginal cost
Output (Q)
Co
sts
(£)
MC
x
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Costs in the Short runCosts in the Short runCosts in the Short runCosts in the Short run
• Marginal costMarginal cost– marginal cost (marginal cost (MCMC) and the law of diminishing ) and the law of diminishing
returnsreturns– the relationship between the marginal and the relationship between the marginal and
total cost curvestotal cost curves
• Average costAverage cost– average fixed cost (average fixed cost (AFCAFC))– average variable cost (average variable cost (AVCAVC))– average (total) cost (average (total) cost (ACAC))
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Costs in the Short runCosts in the Short runCosts in the Short runCosts in the Short run
• Marginal costMarginal cost– marginal cost (marginal cost (MCMC) and the law of diminishing ) and the law of diminishing
returnsreturns– the relationship between the marginal and the relationship between the marginal and
total cost curvestotal cost curves
• Average costAverage cost– average fixed cost (average fixed cost (AFCAFC))– average variable cost (average variable cost (AVCAVC))– average (total) cost (average (total) cost (ACAC))
• Relationship between average and Relationship between average and marginal costmarginal cost
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Average and marginal costsAverage and marginal costsAverage and marginal costsAverage and marginal costs
Output (Q)
Co
sts
(£)
MC
x
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Output (Q)
Co
sts
(£)
MC
x
AVC
y
Average and marginal costsAverage and marginal costsAverage and marginal costsAverage and marginal costs
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Output (Q)
Co
sts
(£)
MC
x
y
AFC
AVC
Average and marginal costsAverage and marginal costsAverage and marginal costsAverage and marginal costs
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Output (Q)
Co
sts
(£)
AFC
AVC
MC
x
AC
y
z
Average and marginal costsAverage and marginal costsAverage and marginal costsAverage and marginal costs