managerial economics and organizational architecture, 5e managerial economics and organizational...
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Managerial Economics and Organizational Architecture, 5e Returns to Scale The relation between output and a proportional variation of all inputs together Increasing returns to scale - if inputs double, output more than doubles Decreasing returns to scale - if inputs double, output less than doubles Constant returns to scale- if inputs double, output doubles 5-3TRANSCRIPT
Managerial Economics and Organizational Architecture, 5e
Managerial Economics and Organizational Architecture, 5e
Chapter 5: Production and Cost
Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.McGraw-Hill/Irwin
Managerial Economics and Organizational Architecture, 5e
Production FunctionsA production function specifies maximum output from given inputs:
),...,( 21 nxxxfQ
5-2
Managerial Economics and Organizational Architecture, 5e
Returns to Scale• The relation between output and a
proportional variation of all inputs together• Increasing returns to scale - if inputs
double, output more than doubles• Decreasing returns to scale - if inputs
double, output less than doubles• Constant returns to scale- if inputs double,
output doubles5-3
Managerial Economics and Organizational Architecture, 5e
Returns to a Factor• The relation between output and the
variation in only one input, holding all other inputs constant
• Total product - amount of output, Q, obtained when an input, L, increases
• Average product Q/L• Marginal product Q/L
5-4
Managerial Economics and Organizational Architecture, 5e
Returns to a Factor
S A Q MPS APS
1 9 3.00 3.00 3.002 9 4.24 1.24 2.123 9 5.20 0.96 1.734 9 6.00 0.80 1.505 9 6.70 0.70 1.34
Production function: Q=S1/2A1/2
5-5
Managerial Economics and Organizational Architecture, 5e
Returns to a Factor:A Common Case
Law of diminishing returns – at somepoint, S1, the marginal product of a variable factor will decline as its use is increased
Quantity of steel
Total product
Average productMarginal
product
S1 S2
S
Qua
ntity
of a
uto
parts
pe
r uni
t of s
teel
Q/SS
Qua
ntity
of a
uto
parts
Q
5-6
Managerial Economics and Organizational Architecture, 5e
Illustrating Production Choices with Isoquants
• Isoquants show all combinations of two inputs that produce the same level of output, assuming efficient production
• Shape of isoquants indicates substitutability between inputs
5-7
Managerial Economics and Organizational Architecture, 5e
Isoquants Isoquants• show all
combinations of two inputs that produce the same level of output
• Moving to the northeast implies greater output S
Qua
ntity
of A
lum
inum
Quantity of Steel
A
200
300
100
5-8
Managerial Economics and Organizational Architecture, 5e
Differing Input SubstitutabilityIsoquants
A
SQuantity of Steel
Qua
ntity
of A
lum
inum
Quantity of SteelQuantity of Steel
Fixed proportions Normal case Perfect substitutes
AA
SS
5-9
Managerial Economics and Organizational Architecture, 5e
Isocost Lines• Isocosts show all combinations of two
inputs that have the same cost• The slope of an isocost line changes as
input prices change
5-10
Managerial Economics and Organizational Architecture, 5e
Isocost LinesQ
uant
ity o
f al
umin
um
Quantity of steel
200
100
$100 line
200 400
$200 line
5-11
Managerial Economics and Organizational Architecture, 5e
Isocost LinesChanges in Input PricesQ
uant
ity o
f alu
min
um
100
Quantity of steel
200
PS = $1.00per pound
PS = $.50per pound
100
A
S
5-12
Managerial Economics and Organizational Architecture, 5e
Optimal Input Mix
• Equilibrium occurs when the isoprofit curve is tangent to the isocost curve
• If the price of one input increases, the firm will reduce its use and substitute relatively cheaper inputs in its place
5-13
Managerial Economics and Organizational Architecture, 5e
Cost MinimizationQ
uant
ity o
f alu
min
um
Quantity of steel
SS’ S*
A*
A’
Q*
5-14
Managerial Economics and Organizational Architecture, 5e
Optimal Input MixInput Price Changes
Qua
ntity
of a
lum
inum
High steelprice
Low steel price
Quantity of steel
SS2 S1
A2
A1
Q*
5-15
Managerial Economics and Organizational Architecture, 5e
Cost Concepts• Total cost
– relation between total cost and output• Marginal cost
– change in total cost when output rises one unit
• Average cost– total cost divided by total output
• Opportunity cost– value of a resource in it next best
alternative 5-16
Managerial Economics and Organizational Architecture, 5e
Cost Curves
Tota
l cos
ts (i
n do
llars
)
Total cost
Q
$
Quantity of output
Cos
t per
uni
t of
outp
ut (in
dol
lars
)
Marginal cost
Average cost
Q1 Q2
Q
$
5-17
Managerial Economics and Organizational Architecture, 5e
Short Run versus Long Run• Short run
– at least one input is fixed– cost curves are operating curves
• Long run– all inputs are variable– cost curves are planning curves
5-18
Managerial Economics and Organizational Architecture, 5e
Fixed versus Variable Costs
• Fixed costs– incurred even if firm produces nothing
• Variable costs– change with the level of output
5-19
Managerial Economics and Organizational Architecture, 5e
Short-Run Cost Curves
Quantity of output
Tota
l cos
ts (i
n do
llars
) Total cost
Total variable cost
$
Cos
t per
uni
t of o
utpu
t
(in d
olla
rs)
Average fixed cost
Q1 Q2 Q3
Marginal cost
Average total cost
Average variable cost
$
Q 5-20
Managerial Economics and Organizational Architecture, 5e
Long-Run Average Costenvelope of short-run average cost curves
$
Q
SRAC1
SRAC2SRAC3
SRAC4
SRAC5SRAC5
5-21
Managerial Economics and Organizational Architecture, 5e
Cost Concepts • Economies of scale
– Average costs fall as output expands• Economies of scope
– cost of producing a joint set of products is less than cost of producing separately in separate firms
5-22
Managerial Economics and Organizational Architecture, 5e
Additional Cost Concepts• Minimum efficient scale
– plant size at which long-run average cost first reaches its minimum point (Q*)
– Helps determine the number of firms in an industry and therefore the level of competition
• Learning curves– costs decline with production experience
5-23
Managerial Economics and Organizational Architecture, 5e
Learning Curve
Average cost of producing Q* units
$
Cos
t per
uni
t of o
utpu
t
(in d
olla
rs)
Cumulative quantity of output produced
Learning curve
ΣQ
5-24
Managerial Economics and Organizational Architecture, 5e
Economies of Scale versus Learning Effects
Quantity of output
Cos
t per
uni
t of o
utpu
t
(in d
olla
rs)
$
Learning effect
Average cost with low cumulative volume
Average cost with high cumulative volume
Q
5-25
Managerial Economics and Organizational Architecture, 5e
Profit Maximization
• A firm should increase output as long as marginal revenue exceeds marginal cost
• A firm should not increase output if marginal cost exceeds marginal revenue
• At the profit-maximizing level of output,
MR=MC
5-26
Managerial Economics and Organizational Architecture, 5e
Optimal Output and Changes in Marginal Cost
Cos
t/rev
enue
per
uni
t(in
dol
lars
)
Quantity of output
MR
MC1
MC0
QQ1Q0
$
5-27
Managerial Economics and Organizational Architecture, 5e
Factor DemandEfficient production requires that
MPi/Pi= MPj/Pj
From which we derive the demand curve (marginal revenue product) for input i
Pi=MRMPi
Marginal revenue product, MRP, is the addition to revenue from using one more unit of an input
5-28
Managerial Economics and Organizational Architecture, 5e
Factor Demand Curve
Quantity of input i
Cos
t/rev
enue
per
uni
t of
inpu
t
(in d
olla
rs)
Q*i
Qi
P*i
MRPi
$
5-29
Managerial Economics and Organizational Architecture, 5e
Cost Estimation• Effective management decisions should
incorporate estimates of short- and long-run costs
• Use regression analysis• Short-run costs may be approximately
linearVC = a + bQ
5-30