Chapter 7 The Cost of Production

Chapter 7 The Cost of Production

اسلاید 1: Chapter 7The Cost of Production

اسلاید 2: Chapter 7Slide 2Topics to be DiscussedMeasuring Cost: Which Costs Matter?Cost in the Short RunCost in the Long RunLong-Run Versus Short-Run Cost Curves

اسلاید 3: Chapter 7Slide 3Topics to be DiscussedProduction with Two Outputs--Economies of ScopeDynamic Changes in Costs--The Learning CurveEstimating and Predicting Cost

اسلاید 4: Chapter 7Slide 4IntroductionThe production technology measures the relationship between input and output.Given the production technology, managers must choose how to produce.

اسلاید 5: Chapter 7Slide 5IntroductionTo determine the optimal level of output and the input combinations, we must convert from the unit measurements of the production technology to dollar measurements or costs.

اسلاید 6: Chapter 7Slide 6Measuring Cost: Which Costs Matter?Accounting CostActual expenses plus depreciation charges for capital equipmentEconomic CostCost to a firm of utilizing economic resources in production, including opportunity costEconomic Cost vs. Accounting Cost

اسلاید 7: Chapter 7Slide 7Opportunity cost.Cost associated with opportunities that are foregone when a firm’s resources are not put to their highest-value use.Measuring Cost: Which Costs Matter?

اسلاید 8: Chapter 7Slide 8An ExampleA firm owns its own building and pays no rent for office spaceDoes this mean the cost of office space is zero?Measuring Cost: Which Costs Matter?

اسلاید 9: Chapter 7Slide 9Sunk CostExpenditure that has been made and cannot be recoveredShould not influence a firm’s decisions.Measuring Cost: Which Costs Matter?

اسلاید 10: Chapter 7Slide 10An ExampleA firm pays $500,000 for an option to buy a building.The cost of the building is $5 million or a total of $5.5 million.The firm finds another building for $5.25 million.Which building should the firm buy?Measuring Cost: Which Costs Matter?

اسلاید 11: Chapter 7Slide 11Choosing the Location for a New Law School BuildingNorthwestern University Law School1) Current location in downtown Chicago2) Alternative location in Evanston with the main campus

اسلاید 12: Chapter 7Slide 12Northwestern University Law School3) Choosing a SiteLand owned in ChicagoMust purchase land in EvanstonChicago location might appear cheaper without considering the opportunity cost of the downtown land (i.e. what it could be sold for)Choosing the Location for a New Law School Building

اسلاید 13: Chapter 7Slide 13Northwestern University Law School3) Choosing a SiteChicago location chosen--very costly Justified only if there is some intrinsic values associated with being in ChicagoIf not, it was an inefficient decision if it was based on the assumption that the downtown land was “free”Choosing the Location for a New Law School Building

اسلاید 14: Chapter 7Slide 14Total output is a function of variable inputs and fixed inputs. Therefore, the total cost of production equals the fixed cost (the cost of the fixed inputs) plus the variable cost (the cost of the variable inputs), or…Measuring Cost: Which Costs Matter?Fixed and Variable Costs

اسلاید 15: Chapter 7Slide 15Fixed CostDoes not vary with the level of outputVariable Cost Cost that varies as output variesMeasuring Cost: Which Costs Matter?Fixed and Variable Costs

اسلاید 16: Chapter 7Slide 16Fixed CostCost paid by a firm that is in business regardless of the level of outputSunk Cost Cost that have been incurred and cannot be recoveredMeasuring Cost: Which Costs Matter?

اسلاید 17: Chapter 7Slide 17Personal Computers: most costs are variable Components, laborSoftware: most costs are sunkCost of developing the softwareMeasuring Cost: Which Costs Matter?

اسلاید 18: Chapter 7Slide 18PizzaLargest cost component is fixedMeasuring Cost: Which Costs Matter?

اسلاید 19: A Firm’s Short-Run Costs ($)050 050------------150501005050501002507812828253964350981482016.732.749.34501121621412.52840.555013018018102636650150200208.32533.3750175225257.12532.1850204254296.325.531.8950242292385.626.932.4105030035058530351150385435854.53539.5Rate ofFixedVariableTotalMarginalAverageAverageAverageOutputCostCostCostCostFixedVariableTotal(FC)(VC)(TC)(MC)CostCostCost(AFC)(AVC)(ATC)

اسلاید 20: Chapter 7Slide 20Cost in the Short RunMarginal Cost (MC) is the cost of expanding output by one unit. Since fixed cost have no impact on marginal cost, it can be written as:

اسلاید 21: Chapter 7Slide 21Cost in the Short RunAverage Total Cost (ATC) is the cost per unit of output, or average fixed cost (AFC) plus average variable cost (AVC). This can be written:

اسلاید 22: Chapter 7Slide 22Cost in the Short RunAverage Total Cost (ATC) is the cost per unit of output, or average fixed cost (AFC) plus average variable cost (AVC). This can be written:

اسلاید 23: Chapter 7Slide 23Cost in the Short RunThe Determinants of Short-Run CostThe relationship between the production function and cost can be exemplified by either increasing returns and cost or decreasing returns and cost.

اسلاید 24: Chapter 7Slide 24Cost in the Short RunThe Determinants of Short-Run CostIncreasing returns and costWith increasing returns, output is increasing relative to input and variable cost and total cost will fall relative to output.Decreasing returns and costWith decreasing returns, output is decreasing relative to input and variable cost and total cost will rise relative to output.

اسلاید 25: Chapter 7Slide 25Cost in the Short RunFor Example: Assume the wage rate (w) is fixed relative to the number of workers hired. Then:

اسلاید 26: Chapter 7Slide 26Cost in the Short RunContinuing:

اسلاید 27: Chapter 7Slide 27Cost in the Short RunContinuing:

اسلاید 28: Chapter 7Slide 28Cost in the Short RunIn conclusion:…and a low marginal product (MP) leads to a high marginal cost (MC) and vise versa.

اسلاید 29: Chapter 7Slide 29Cost in the Short RunConsequently (from the table):MC decreases initially with increasing returns 0 through 4 units of outputMC increases with decreasing returns5 through 11 units of output

اسلاید 30: A Firm’s Short-Run Costs ($)050 050------------150501005050501002507812828253964350981482016.732.749.34501121621412.52840.555013018018102636650150200208.32533.3750175225257.12532.1850204254296.325.531.8950242292385.626.932.4105030035058530351150385435854.53539.5Rate ofFixedVariableTotalMarginalAverageAverageAverageOutputCostCostCostCostFixedVariableTotal(FC)(VC)(TC)(MC)CostCostCost(AFC)(AVC)(ATC)

اسلاید 31: Chapter 7Slide 31Cost Curves for a FirmOutputCost($ peryear)100200300400012345678910111213VCVariable costincreases with production andthe rate varies withincreasing &decreasing returns.TCTotal costis the verticalsum of FC and VC.FC50Fixed cost does notvary with output

اسلاید 32: Chapter 7Slide 32Cost Curves for a FirmOutput (units/yr.)Cost($ perunit)25507510001234567891011MCATCAVCAFC

اسلاید 33: Chapter 7Slide 33Cost Curves for a FirmThe line drawn from the origin to the tangent of the variable cost curve:Its slope equals AVCThe slope of a point on VC equals MCTherefore, MC = AVC at 7 units of output (point A)OutputP100200300400012345678910111213FCVCATC

اسلاید 34: Chapter 7Slide 34Cost Curves for a FirmUnit CostsAFC falls continuouslyWhen MC < AVC or MC < ATC, AVC & ATC decreaseWhen MC > AVC or MC > ATC, AVC & ATC increaseOutput (units/yr.)Cost($ perunit)25507510001234567891011MCATCAVCAFC

اسلاید 35: Chapter 7Slide 35Cost Curves for a FirmUnit CostsMC = AVC and ATC at minimum AVC and ATCMinimum AVC occurs at a lower output than minimum ATC due to FCOutput (units/yr.)Cost($ perunit)25507510001234567891011MCATCAVCAFC

اسلاید 36: Chapter 7Slide 36Operating Costs for Aluminum Smelting ($/Ton - based on an output of 600 tons/day)Variable costs that are constant at all output levelsElectricity$316Alumina369Other raw materials125Plant power and fuel10 Subtotal$820

اسلاید 37: Chapter 7Slide 37Operating Costs for Aluminum Smelting ($/Ton - based on an output of 600 tons/day)Variable costs that increase when output exceeds 600 tons/dayLabor$150Maintenance120Freight50 Subtotal$320Total operating costs$1140

اسلاید 38: Chapter 7Slide 38The Short-Run Variable Costs of Aluminum SmeltingOutput (tons/day) Cost($ per ton)1100120013003006009001140MCAVC

اسلاید 39: Chapter 7Slide 39Cost in the Long RunUser Cost of Capital = Economic Depreciation + (Interest Rate)(Value of Capital)The User Cost of Capital

اسلاید 40: Chapter 7Slide 40Cost in the Long RunExampleDelta buys a Boeing 737 for $150 million with an expected life of 30 yearsAnnual economic depreciation = $150 million/30 = $5 millionInterest rate = 10%The User Cost of Capital

اسلاید 41: Chapter 7Slide 41Cost in the Long RunExampleUser Cost of Capital = $5 million + (.10)($150 million – depreciation)Year 1 = $5 million + (.10)($150 million) = $20 millionYear 10 = $5 million + (.10)($100 million) = $15 millionThe User Cost of Capital

اسلاید 42: Chapter 7Slide 42Cost in the Long RunRate per dollar of capitalr = Depreciation Rate + Interest RateThe User Cost of Capital

اسلاید 43: Chapter 7Slide 43Cost in the Long RunAirline ExampleDepreciation Rate = 1/30 = 3.33/yrRate of Return = 10%/yrUser Cost of Capitalr = 3.33 + 10 = 13.33%/yrThe User Cost of Capital

اسلاید 44: Chapter 7Slide 44Cost in the Long RunAssumptionsTwo Inputs: Labor (L) & capital (K)Price of labor: wage rate (w)The price of capitalR = depreciation rate + interest rateThe Cost Minimizing Input Choice

اسلاید 45: Chapter 7Slide 45Cost in the Long RunQuestionIf capital was rented, would it change the value of r ?The User Cost of CapitalThe Cost Minimizing Input Choice

اسلاید 46: Chapter 7Slide 46Cost in the Long RunThe Isocost LineC = wL + rKIsocost: A line showing all combinations of L & K that can be purchased for the same costThe User Cost of CapitalThe Cost Minimizing Input Choice

اسلاید 47: Chapter 7Slide 47Cost in the Long RunRewriting C as linear:K = C/r - (w/r)LSlope of the isocost: is the ratio of the wage rate to rental cost of capital.This shows the rate at which capital can be substituted for labor with no change in cost.The Isocost Line

اسلاید 48: Chapter 7Slide 48Choosing Inputs We will address how to minimize cost for a given level of output.We will do so by combining isocosts with isoquants

اسلاید 49: Chapter 7Slide 49Producing a Given Output at Minimum CostLabor per yearCapitalperyearIsocost C2 shows quantity Q1 can be produced withcombination K2L2 or K3L3.However, both of theseare higher cost combinationsthan K1L1.Q1Q1 is an isoquantfor output Q1.Isocost curve C0 showsall combinations of K and Lthat can produce Q1 at thiscost level.C0C1C2CO C1 C2 arethreeisocost linesAK1L1K3L3K2L2

اسلاید 50: Chapter 7Slide 50Input Substitution When an Input Price ChangeC2This yields a new combinationof K and L to produce Q1.Combination B is used in placeof combination A.The new combination represents the higher cost of labor relativeto capital and therefore capital is substituted for labor.K2L2BC1K1L1AQ1If the price of laborchanges, the isocost curvebecomes steeper due to the change in the slope -(w/L).Labor per yearCapitalperyear

اسلاید 51: Chapter 7Slide 51Cost in the Long RunIsoquants and Isocosts and the Production Function

اسلاید 52: Chapter 7Slide 52Cost in the Long RunThe minimum cost combination can then be written as:Minimum cost for a given output will occur when each dollar of input added to the production process will add an equivalent amount of output.

اسلاید 53: Chapter 7Slide 53Cost in the Long RunQuestionIf w = $10, r = $2, and MPL = MPK, which input would the producer use more of? Why?

اسلاید 54: Chapter 7Slide 54The Effect of Effluent Fees on Firms’ Input ChoicesFirms that have a by-product to production produce an effluent.An effluent fee is a per-unit fee that firms must pay for the effluent that they emit.How would a producer respond to an effluent fee on production?

اسلاید 55: Chapter 7Slide 55The Scenario: Steel Producer1)Located on a river: Low cost transportation and emission disposal (effluent).2) EPA imposes a per unit effluent fee to reduce the environmentally harmful effluent.The Effect of Effluent Fees on Firms’ Input Choices

اسلاید 56: Chapter 7Slide 56The Scenario: Steel Producer3)How should the firm respond?The Effect of Effluent Fees on Firms’ Input Choices

اسلاید 57: Chapter 7Slide 57The Cost-Minimizing Response to an Effluent FeeWaste Water(gal./month)Capital(machine hours permonth)Output of 2,000Tons of Steel per MonthA10,00018,00020,000012,000Slope of isocost = -10/40 = -0.252,0001,0004,0003,0005,0005,000

اسلاید 58: Chapter 7Slide 58The Cost-Minimizing Response to an Effluent FeeOutput of 2,000Tons of Steel per Month2,0001,0004,0003,0005,00010,00018,00020,000012,000Capital(machine hours permonth)E5,0003,500Slope of isocost = -20/40= -0.50BFollowing the impositionof the effluent fee of $10/gallonthe slope of the isocost changeswhich the higher cost of water tocapital so now combination B is selected.APrior to regulation the firm chooses to produce an output using 10,000 gallons of water and 2,000machine-hours of capital at A.CFWaste Water(gal./month)

اسلاید 59: Chapter 7Slide 59Observations:The more easily factors can be substituted, the more effective the fee is in reducing the effluent.The greater the degree of substitutes, the less the firm will have to pay (for example: $50,000 with combination B instead of $100,000 with combination A)The Effect of Effluent Fees on Firms’ Input Choices

اسلاید 60: Chapter 7Slide 60Cost minimization with Varying Output LevelsA firm’s expansion path shows the minimum cost combinations of labor and capital at each level of output.Cost in the Long Run

اسلاید 61: Chapter 7Slide 61A Firm’s Expansion PathLabor per yearCapitalperyearExpansion PathThe expansion path illustratesthe least-cost combinations oflabor and capital that can be used to produce each level ofoutput in the long-run.25507510015010050150300200A$2000Isocost Line200 UnitIsoquantB$3000 Isocost Line300 Unit IsoquantC

اسلاید 62: Chapter 7Slide 62A Firm’s Long-Run Total Cost CurveOutput, Units/yrCostperYearExpansion Path100010030020020003000DEF

اسلاید 63: Chapter 7Slide 63Long-Run Versus Short-Run Cost CurvesWhat happens to average costs when both inputs are variable (long run) versus only having one input that is variable (short run)?

اسلاید 64: Chapter 7Slide 64Long-RunExpansion PathThe long-run expansionpath is drawn as before..The Inflexibility of Short-Run ProductionLabor per yearCapitalperyearL2Q2K2DCFEQ1ABL1K1L3PShort-RunExpansion Path

اسلاید 65: Chapter 7Slide 65Long-Run Average Cost (LAC)Constant Returns to ScaleIf input is doubled, output will double and average cost is constant at all levels of output.Long-Run Versus Short-Run Cost Curves

اسلاید 66: Chapter 7Slide 66Long-Run Average Cost (LAC)Increasing Returns to ScaleIf input is doubled, output will more than double and average cost decreases at all levels of output.Long-Run Versus Short-Run Cost Curves

اسلاید 67: Chapter 7Slide 67Long-Run Average Cost (LAC)Decreasing Returns to ScaleIf input is doubled, the increase in output is less than twice as large and average cost increases with output.Long-Run Versus Short-Run Cost Curves

اسلاید 68: Chapter 7Slide 68Long-Run Average Cost (LAC)In the long-run:Firms experience increasing and decreasing returns to scale and therefore long-run average cost is “U” shaped.Long-Run Versus Short-Run Cost Curves

اسلاید 69: Chapter 7Slide 69Long-Run Average Cost (LAC)Long-run marginal cost leads long-run average cost:If LMC < LAC, LAC will fallIf LMC > LAC, LAC will riseTherefore, LMC = LAC at the minimum of LACLong-Run Versus Short-Run Cost Curves

اسلاید 70: Chapter 7Slide 70Long-Run Average and Marginal CostOutputCost($ per unitof outputLACLMCA

اسلاید 71: Chapter 7Slide 71QuestionWhat is the relationship between long-run average cost and long-run marginal cost when long-run average cost is constant?Long-Run Versus Short-Run Cost Curves

اسلاید 72: Chapter 7Slide 72Economies and Diseconomies of ScaleEconomies of ScaleIncrease in output is greater than the increase in inputs.Diseconomies of ScaleIncrease in output is less than the increase in inputs.Long-Run Versus Short-Run Cost Curves

اسلاید 73: Chapter 7Slide 73Measuring Economies of ScaleLong-Run Versus Short-Run Cost Curves

اسلاید 74: Chapter 7Slide 74Measuring Economies of ScaleLong-Run Versus Short-Run Cost Curves

اسلاید 75: Chapter 7Slide 75Therefore, the following is true:EC < 1: MC < ACAverage cost indicate decreasing economies of scaleEC = 1: MC = ACAverage cost indicate constant economies of scaleEC > 1: MC > ACAverage cost indicate increasing diseconomies of scaleLong-Run Versus Short-Run Cost Curves

اسلاید 76: Chapter 7Slide 76The Relationship Between Short-Run and Long-Run CostWe will use short and long-run cost to determine the optimal plant sizeLong-Run Versus Short-Run Cost Curves

اسلاید 77: Chapter 7Slide 77Long-Run Cost with Constant Returns to ScaleOutputCost($ per unitof outputQ3SAC3SMC3Q2SAC2SMC2LAC =LMCWith many plant sizes with SAC = $10the LAC = LMC and is a straight lineQ1SAC1SMC1

اسلاید 78: Chapter 7Slide 78ObservationThe optimal plant size will depend on the anticipated output (e.g. Q1 choose SAC1,etc).The long-run average cost curve is the envelope of the firm’s short-run average cost curves.QuestionWhat would happen to average cost if an output level other than that shown is chosen?Long-Run Cost with Constant Returns to Scale

اسلاید 79: Chapter 7Slide 79Long-Run Cost with Economies and Diseconomies of ScaleOutputCost($ per unitof outputSMC1SAC1SAC2SMC2LMC If the output is Q1 a managerwould chose the small plantSAC1 and SAC $8.Point B is on the LAC because it is a least cost plant for a given output.$10Q1$8BALAC SAC3SMC3

اسلاید 80: Chapter 7Slide 80What is the firms’ long-run cost curve?Firms can change scale to change output in the long-run.The long-run cost curve is the dark blue portion of the SAC curve which represents the minimum cost for any level of output.Long-Run Cost with Constant Returns to Scale

اسلاید 81: Chapter 7Slide 81ObservationsThe LAC does not include the minimum points of small and large size plants? Why not?LMC is not the envelope of the short-run marginal cost. Why not?Long-Run Cost with Constant Returns to Scale

اسلاید 82: Chapter 7Slide 82Production with Two Outputs--Economies of ScopeExamples:Chicken farm--poultry and eggsAutomobile company--cars and trucksUniversity--Teaching and research

اسلاید 83: Chapter 7Slide 83Economies of scope exist when the joint output of a single firm is greater than the output that could be achieved by two different firms each producing a single output.What are the advantages of joint production?Consider an automobile company producing cars and tractorsProduction with Two Outputs--Economies of Scope

اسلاید 84: Chapter 7Slide 84Advantages1)Both use capital and labor.2)The firms share management resources.3)Both use the same labor skills and type of machinery.Production with Two Outputs--Economies of Scope

اسلاید 85: Chapter 7Slide 85Production:Firms must choose how much of each to produce.The alternative quantities can be illustrated using product transformation curves.Production with Two Outputs--Economies of Scope

اسلاید 86: Chapter 7Slide 86Product Transformation CurveNumber of carsNumberof tractorsO2O1 illustrates a low levelof output. O2 illustratesa higher level of output withtwo times as much labor and capital.O1Each curve showscombinations of output with a given combination of L & K.

اسلاید 87: Chapter 7Slide 87ObservationsProduct transformation curves are negatively slopedConstant returns exist in this exampleSince the production transformation curve is concave is joint production desirable?Production with Two Outputs--Economies of Scope

اسلاید 88: Chapter 7Slide 88ObservationsThere is no direct relationship between economies of scope and economies of scale.May experience economies of scope and diseconomies of scaleMay have economies of scale and not have economies of scope Production with Two Outputs--Economies of Scope

اسلاید 89: Chapter 7Slide 89The degree of economies of scope measures the savings in cost and can be written:C(Q1) is the cost of producing Q1C(Q2) is the cost of producing Q2C(Q1Q2) is the joint cost of producing both productsProduction with Two Outputs--Economies of Scope

اسلاید 90: Chapter 7Slide 90Interpretation:If SC > 0 -- Economies of scopeIf SC < 0 -- Diseconomies of scopeProduction with Two Outputs--Economies of Scope

اسلاید 91: Chapter 7Slide 91Economies of Scope in the Trucking IndustryIssuesTruckload versus less than truck loadDirect versus indirect routingLength of haul

اسلاید 92: Chapter 7Slide 92Questions:Economies of ScaleAre large-scale, direct hauls cheaper and more profitable than individual hauls by small trucks?Are there cost advantages from operating both direct and indirect hauls?Economies of Scope in the Trucking Industry

اسلاید 93: Chapter 7Slide 93Empirical FindingsAn analysis of 105 trucking firms examined four distinct outputs.Short hauls with partial loadsIntermediate hauls with partial loadsLong hauls with partial loadsHauls with total loadsEconomies of Scope in the Trucking Industry

اسلاید 94: Chapter 7Slide 94Empirical FindingsResultsSC = 1.576 for reasonably large firmSC = 0.104 for very large firmsInterpretationCombining partial loads at an intermediate location lowers cost management difficulties with very large firms.Economies of Scope in the Trucking Industry

اسلاید 95: Chapter 7Slide 95Dynamic Changes in Costs--The Learning CurveThe learning curve measures the impact of worker’s experience on the costs of production.It describes the relationship between a firm’s cumulative output and amount of inputs needed to produce a unit of output.

اسلاید 96: Chapter 7Slide 96The Learning CurveCumulative number of machine lots producedHours of laborper machine lot10203040500246810

اسلاید 97: Chapter 7Slide 97The Learning CurveHours of laborper machine lot10203040500246810The horizontal axis measures the cumulative number of hours of machine tools the firm has producedThe vertical axis measures the number of hours of labor needed to produce each lot.

اسلاید 98: Chapter 7Slide 98The learning curve in the figure is based on the relationship:Dynamic Changes in Costs--The Learning Curve

اسلاید 99: Chapter 7Slide 99 L equals A + B and this measures labor input to produce the first unit of output Labor input remains constant as the cumulative level of output increases, so there is no learningDynamic Changes in Costs--The Learning Curve

اسلاید 100: Chapter 7Slide 100 L approaches A, and A represent minimum labor input/unit of output after all learning has taken place. The more important the learning effect.Dynamic Changes in Costs--The Learning Curve

اسلاید 101: Chapter 7Slide 101The Learning CurveCumulative number ofmachine lots producedHours of laborper machine lot10203040500246810The chart shows a sharp dropin lots to a cumulative amount of20, then small savings at higher levels.Doubling cumulative output causesa 20% reduction in the difference between the input required and minimum attainable input requirement.

اسلاید 102: Chapter 7Slide 102Observations1) New firms may experience a learning curve, not economies of scale.2)Older firms have relatively small gains from learning.Dynamic Changes in Costs--The Learning Curve

اسلاید 103: Chapter 7Slide 103Economies of Scale Versus LearningOutputCost($ per unitof output)AC1BEconomies of ScaleAAC2LearningC

اسلاید 104: Predicting the Labor Requirements of Producing a Given Output101.0010.020.8018.0 (10.0 + 8.0)30.7025.0 (18.0 + 7.0)40.6431.4 (25.0 + 6.4)50.6037.4 (31.4 + 6.0)60.5643.0 (37.4 + 5.6)70.5348.3 (43.0 + 5.3)80 and over.5153.4 (48.3 + 5.1)Cumulative OutputPer-Unit Labor RequirementTotal Labor(N)for each 10 units of Output (L)Requirement

اسلاید 105: Chapter 7Slide 105The learning curve implies:1) The labor requirement falls per unit.2)Costs will be high at first and then will fall with learning.3)After 8 years the labor requirement will be 0.51 and per unit cost will be half what it was in the first year of production.Dynamic Changes in Costs--The Learning Curve

اسلاید 106: Chapter 7Slide 106ScenarioA new firm enters the chemical processing industry.Do they:1) Produce a low level of output and sell at a high price?2)Produce a high level of output and sell at a low price?The Learning Curve in Practice

اسلاید 107: Chapter 7Slide 107The Learning Curve in PracticeHow would the learning curve influence your decision?

اسلاید 108: Chapter 7Slide 108The Empirical FindingsStudy of 37 chemical productsAverage cost fell 5.5% per yearFor each doubling of plant size, average production costs fall by 11%For each doubling of cumulative output, the average cost of production falls by 27%Which is more important, the economies of scale or learning effects?The Learning Curve in Practice

اسلاید 109: Chapter 7Slide 109Other Empirical FindingsIn the semi-conductor industry a study of seven generations of DRAM semiconductors from 1974-1992 found learning rates averaged 20%.In the aircraft industry the learning rates are as high as 40%.The Learning Curve in Practice

اسلاید 110: Chapter 7Slide 110Applying Learning Curves1) To determine if it is profitable to enter an industry.2)To determine when profits will occur based on plant size and cumulative output.The Learning Curve in Practice

اسلاید 111: Chapter 7Slide 111Estimating and Predicting CostEstimates of future costs can be obtained from a cost function, which relates the cost of production to the level of output and other variables that the firm can control.Suppose we wanted to derive the total cost curve for automobile production.

اسلاید 112: Chapter 7Slide 112Total Cost Curve for the Automobile IndustryQuantity of CarsVariablecostGeneral MotorsToyotaFordChryslerVolvoHondaNissan

اسلاید 113: Chapter 7Slide 113A linear cost function (does not show the U-shaped characteristics) might be:The linear cost function is applicable only if marginal cost is constant. Marginal cost is represented by . Estimating and Predicting Cost

اسلاید 114: Chapter 7Slide 114If we wish to allow for a U-shaped average cost curve and a marginal cost that is not constant, we might use the quadratic cost function:Estimating and Predicting Cost

اسلاید 115: Chapter 7Slide 115If the marginal cost curve is not linear, we might use a cubic cost function:Estimating and Predicting Cost

اسلاید 116: Chapter 7Slide 116Cubic Cost FunctionOutput(per time period) Cost($ per unit)

اسلاید 117: Chapter 7Slide 117Difficulties in Measuring Cost1)Output data may represent an aggregate of different type of products.2)Cost data may not include opportunity cost.3)Allocating cost to a particular product may be difficult when there is more than one product line.Estimating and Predicting Cost

اسلاید 118: Chapter 7Slide 118Cost Functions and the Measurement of Scale EconomiesScale Economy Index (SCI)EC = 1, SCI = 0: no economies or diseconomies of scaleEC > 1, SCI is negative: diseconomies of scaleEC < 1, SCI is positive: economies of scaleEstimating and Predicting Cost

اسلاید 119: Chapter 7Slide 119Cost Functions for Electric PowerScale Economies in the Electric Power IndustryOutput (million kwh)43338110922265819Value of SCI, 1955.41.26.16.10.04

اسلاید 120: Chapter 7Slide 120Average Cost of Production in the Electric Power IndustryOutput (billions of kwh) AverageCost(dollar/1000 kwh)5.05.56.06.56121824303619551970A

اسلاید 121: Chapter 7Slide 121Cost Functions for Electric PowerFindingsDecline in costNot due to economies of scaleWas caused by:Lower input cost (coal & oil)Improvements in technology

اسلاید 122: Chapter 7Slide 122A Cost Function for the Savings and Loan IndustryThe empirical estimation of a long-run cost function can be useful in the restructuring of the savings and loan industry in the wake of the savings and loan collapse in the 1980s.

اسلاید 123: Chapter 7Slide 123Data for 86 savings and loans for 1975 & 1976 in six western statesQ = total assets of each S&LLAC = average operating expenseQ & TC are measured in hundreds of millions of dollarsAverage operating cost are measured as a percentage of total assets.A Cost Function for the Savings and Loan Industry

اسلاید 124: Chapter 7Slide 124A quadratic long-run average cost function was estimated for 1975:Minimum long-run average cost reaches its point of minimum average total cost when total assets of the savings and loan reach $574 million.A Cost Function for the Savings and Loan Industry

اسلاید 125: Chapter 7Slide 125Average operating expenses are 0.61% of total assets.Almost all of the savings and loans in the region being studied had substantially less than $574 million in assets.A Cost Function for the Savings and Loan Industry

اسلاید 126: Chapter 7Slide 126Questions1) What are the implications of the analysis for expansion and mergers?2)What are the limitations of using these results?A Cost Function for the Savings and Loan Industry

اسلاید 127: Chapter 7Slide 127SummaryManagers, investors, and economists must take into account the opportunity cost associated with the use of the firm’s resources.Firms are faced with both fixed and variable costs in the short-run.

اسلاید 128: Chapter 7Slide 128SummaryWhen there is a single variable input, as in the short run, the presence of diminishing returns determines the shape of the cost curves.In the long run, all inputs to the production process are variable.

اسلاید 129: Chapter 7Slide 129SummaryThe firm’s expansion path describes how its cost-minimizing input choices vary as the scale or output of its operation increases.The long-run average cost curve is the envelope of the short-run average cost curves.

اسلاید 130: Chapter 7Slide 130SummaryA firm enjoys economies of scale when it can double its output at less than twice the cost.Economies of scope arise when the firm can produce any combination of the two outputs more cheaply than could two independent firms that each produced a single product.

اسلاید 131: Chapter 7Slide 131SummaryA firm’s average cost of production can fall over time if the firm “learns” how to produce more effectively.Cost functions relate the cost of production to the level of output of the firm.

اسلاید 132: End of Chapter 7The Cost of Productio