Lecture Issues in economics today - Chapter 5

When you finish this chapter, you should: Define the key terms of economics and opportunity cost and understand how a production possibilities frontier exemplifies the trade-offs that exist in life, distinguish between increasing and constant opportunity cost and understand why each might happen in the real world, analyze an argument by thinking economically, while recognizing and avoiding logical traps.
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Lecture Issues in economics today - Chapter 5 Chapter 5 Firm Production, Cost, and Revenue McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Chapter Outline • Production • Costs • Revenue • Profit and Profit Maximization McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Basic Definitions • Profit: The money that business makes: Revenue minus Cost • Cost: the expense that must be incurred in order to produce goods for sale • Revenue : the money that comes into the firm from the sale of their goods McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Economic vs. Accounting Cost • Economic Cost: All costs, both those that must be paid as well as those incurred in the form of forgone opportunities, of a business • Accounting Cost: Only those costs that must be explicitly paid by the owner of a business McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Production • Production Function: a graph which shows how many resources we need to produce various amounts of output • Cost Function: a graph which shows how much various amounts of production cost McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Inputs to Production • Fixed Inputs: resources that you cannot change • Variable Inputs : resources that can be easily changed McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Concepts in Production • Division of Labor: workers divide up the tasks in such a way that each can build up a momentum and not have to switch jobs • Diminishing Returns: the notion that there exists a point where the addition of resources increases production but does so at a decreasing rate McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Figure 1 The Production Function Output D Production C Function B A Workers McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. A Numerical Example Labor Total Output Extra Output of the Group 0 0 1 100 100 2 317 217 3 500 183 4 610 110 5 700 90 6 770 70 7 830 60 8 870 40 9 900 30 13 1000 McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Costs • Fixed Costs: costs of production that we cannot change • Variable Costs: costs of production that we can change McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Figure 2 The Total Cost Function Total Cost D Total Cost Function C B A Output McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Cost Concepts • Marginal Cost: the addition to cost associated with one additional unit of output • Average Total Cost: Total Cost/Output, the cost per unit of production • Average Variable Cost: Total Variable Cost/Output, the average variable cost per unit of production • Average Fixed Cost: Total Fixed Cost/Output, the average fixed cost per unit of production McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Figure 3 Marginal Cost, Average Total, Average Variable, and P Average ...