Chapter 4 - Costs of Production

Chapter 4 - Costs of Production

Part III Chapter 4 Costs of Production Vegan Or Meat Eater Question: What is the opportunity cost to produce one more bushel of vegetables? Question: What is the opportunity cost to produce one more bushel of vegetables? We tend to think of opportunity cost in single units, hence, how many bushes of vegetables were given up to produce on more cow? Even if they did not want to produce any vegetables, they forego producing vegetables for cows For each cow produced, 50 bushels of vegetables were not produced therefore this is our opportunity cost 50 bushels : 1 cow OR 1 bushel: 1/50th of cow

Car How much does it cost to own a car? Using Visual 4A: Opportunity cost of a car, write down the range of direct expenses under the $ heading Using Visual 4B: Transfer your 4A list to the empty space Where else could the money have been spent Add these to the opportunity cost column (Not $ value) List the future uses as well What is the opportunity cost of maintaining the car in working order? What else could be purchased with the money? What are you going to do to raise the money necessary to cover the $$ cost? What is the cost of using our own resources? Time -> Implicit cost, there is no cash outlay but we give up doing something else Any others? less room in garage, your effect on the environment, and etc.

Having a car would (benefit) reduce the time spent getting to places vs walking or biking What is the implicit cost? Missing out on the exercise Opportunity Cost of College Types of Expenses Tuition and Fees Books and Supplies Room and Board Transportation Room and board is something you NEED regardless of your choice Suppose that the alternative is living in your old room at home, this still does NOT eliminate the cost since your family COULD have rented out the room => Sacrificed! Thus, the room and board expense should be EXCLUDED from the

opportunity cost Tuition and Books are $$ ONLY when you attend college, they represent something sacrificed for THAT choice and is part of opportunity cost Costs that are PAID OUT are called explicit cost An implicit cost sacrifices for which no money changes hands In this example, the biggest sacrifice in this category is time.. But what is that time worth? This depends on what you would be doing if you were not in school working a full time job => foregone income Suppose highschool graduate working full time can earn $22,000, if we assume that only 9 months of work must be sacrificed when attending college, then the forgone income is 9 /12 months of $22,000 => $16,500 In production Economic Cost = Direct Cost + Indirect Cost (aka Opp

Cost) Economic Cost = Explicit Cost + Indirect Cost Economic Cost = Accounting cost + Opportunity Cost Question Suppose Jessica is a freelance writer who decides to see a movie. The ticket price is $10, and the entire activity including getting there and back will take 3 hours out of her evening. What is the economic cost of seeing this movie? Suppose that Jessica earns $20/hr as a writer Each hour that Jessica chooses NOT to work causes her to give up $20 in earnings Economic cost = Direct + indirect cost = Explicit + Implicit = $10 (Ticket) + ($20/hr x 3 hours) = 10 + 60 = $70 in opportunity cost The idea that $70 is quite ridiculous, but if you think about it, $70 is a much better estimate than $10 of what the movie costs for Jessica because she gives up 3

hours that could have been spent working on an article that on average would provide her with another $60. Suppose Samantha is an attorney who bills out her time at $100/hr. For her, the economic cost of the same movie (3 hours + the ticket) would be $310!!! Why would Samantha/Jessica would ever see a movie at such a high cost? When the benefits of the movie are GREATER than the explicit and implicit costs Imagine Samantha takes on more and more clients and works longer and longer, earning more income. At some point, Samantha, will realize that leisure activities like movies are important while earning income will seem less important Opportunity Costs You have a ticket to see your favorite musician in concert. You need to decide whether you will take an airplane or the bus to the show. You must pay for the

transportation yourself. The bus trip will take you five hours. It will only take one hour if you fly. Assume the airfare is $150 and the bus fare is $50. Bus or Fly? You have a ticket to see your favorite musician in concert. You need to decide whether you will take an airplane or the bus to the show. You must pay for the transportation yourself. The bus trip will take you five hours. It will only take one hour if you fly. Assume the airfare is $150 and the bus fare is $50. Assume nothing else changes; the rest of the world is standing still. If you could earn six dollars per hour when not on the bus or airplane, which mode of transportation would be cheaper? Correction from Last Class Economic Cost = Direct Cost + Indirect Cost Therefore EC of busing = $50 (ticket for taking the bus) + (5 hours * $6/hr) = $80

EC of Flying = $150 + (1 hour * $6/hr) = $156 Therefore it is better if we BUS Question By taking an airplane, Mr. Lai can travel from Vancouver to Kelowna for his MTG tournament in 1 hour. The same trip takes 5 hours by bus. Airfare is $90 and bus fare is $30. Mr. Lai, when not traveling, can work and earn $30/hour 1. What is the economic cost (EC) for Mr. Lai of traveling by bus? 2. What is the EC for Mr. Lai of traveling by plane? 3. Which is the cheaper mode of travel for Mr. Lai 4. How would the answers be different for another person (ie: Mr. OG who can work and earn $6/hour at a local food store when not traveling)? What is the economic cost (eC) for Mr. Lai of traveling by bus? Economic Cost = Direct Cost + Indirect Cost = $30 + (5 hours) * ($30/Hr) = $180

What is the EC for Mr. Lai of traveling by plane? EC (plane) = $90 + (1 hour) ($6/hour) = $96 Which is the cheaper mode of travel for Mr. Lai Taking the Plane!! How would the answers be different for another person (ie: Mr. OG who can work and earn $6/hour at a local food store when not traveling)? EC (bus) = $30 + (5 hours)($6/hour) = $60 EC (plane) = $90 + (1 hour) ($6/hour) = $96 Therefore, bus is cheaper for Mr. OG Implicit Vs Opportunity Costs Opportunity Cost is the sacrifice given or the cost given up for getting the alternative. Eg:- i go to school everyday sacrificing my sleep so here sleep is my opportunity cost and education at

school is the better alternative. Implicit Cost is a slightly tilted concept. It is the cost of self owned inputs used in the production process of a commodity. Eg:- if my father runs a business and he has a car idle at home and if he uses that car in business then it is his implicit cost i.e. cost of self imposed fixed asset. Inputs are combined to make total product. The overall quantity of output produced with a given workforce Includes all variable inputs

Other product measures include: average product, which is total product divided by the number of workers marginal product, which is the extra total product associated with an additional worker Try the Stations (6 groups) Average Product The quantity of output produced per worker Average Product = Total Product (q) # of workers (L) The Law of Diminishing Marginal Returns Short-run production is determined by the law of diminishing marginal returns. According to this law: the addition of more variable input causes marginal product to fall after some point

average product also falls after some point Copyright 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Total Product (q) (workers (T-shirts per day) per day) 0 0 1 80 2

200 3 250 4 270 5 280 6 270 Marginal Product (q/L)q/L)q/L)L)

(T-shirts per day) 80 120 50 20 10 -10 Average Product (q/L)L) (T-shirts per day) 80 100 83.3 67.5 56

45 300 250 TP 200 150 100 50 0 -- 1 2 3

4 5 6 Number of Workers Employed per Day T-Shirts Produced per Day Labour (L) T-Shirts Produced per Day Total, Marginal, and Average Products Diminishing returns set in 120 100

80 60 AP 40 20 0 -20 1 2 3 4 5 6

MP Number of Workers Employed per Day 300 250 TP 200 150 100 50 0 1 2 3

4 5 6 Number of Workers Employed per Day T-Shirts Produced per Day First Part Top graphs first range, total product total product RISES at an INCREASING rate (thus, + slope) The bottom graph, marginal product RISES as more workers are ADDED

T-Shirts Produced per Day Three Stages of Production Diminishing returns set in 120 100 80 60 AP 40 20 0 -20 1

2 3 4 5 6 MP Number of Workers Employed per Day T-Shirts Produced per Day 250 TP

200 150 100 50 0 1 2 3 4 5 6 Number of Workers Employed per Day T-Shirts Produced per Day

Second Part Marginal product begins to fall but is still positive Total product continues to rise, but at a lower rate (curve becomes flatter) 300 Diminishing returns set in 120 100 80 60 AP

40 20 0 -20 1 2 3 4 5 6 MP Number of Workers Employed per Day

T-Shirts Produced per Day 250 TP 200 150 100 50 0 1 2 3 4 5

6 Number of Workers Employed per Day T-Shirts Produced per Day Third Part Marginal product falls BELOW zero Total Product decreases 300 Diminishing returns set in 120 100 80 60

AP 40 20 0 -20 1 2 3 4 5 6 MP

Number of Workers Employed per Day Average Vs Marginal Product Lets use EXAMS as an example (get the pun?) Marginal mark is the mark on each test Average mark is the total earned so far divided by the number of completed tests IE: Marginal Mark for Test 1: 36/50 Marginal Mark for Test 2: 34/50 Average Mark: (36+34)/2 = 35 Costs in the Short Run Fixed Costs (costs of all fixed inputs) Variable Costs (costs of all variable inputs) Total Costs (FC + VC) Marginal Cost Marginal cost is the extra cost of producing another

unit of output. It equals the change in total cost divided by the change in total product. The marginal cost curve is shaped like a J because of the law of diminishing marginal returns. Marginal Cost 12 MC 10 $ per T-Shirt 8 6 Diminishing returns set in

4 2 0 50 100 150 200 250 300 Quantity of T-Shirts Produced Per Day Copyright 2009 by McGraw-Hill Ryerson Limited.

All rights reserved. Per-Unit Costs Think-Pair-Share What does it mean? What does it include? Avg FC (FC divided by total product produced) Avg VC (VC divided by total product produced) Average cost Total cost / Total Product Avg FC + Avg VC You try! Try this worksheet! Short-Run Costs for Pure n Simple T-Shirts Labour (L) Total Marginal Fixed Variable Product Product Costs Costs

(MP) (q) (FC) (VC) 0 0 1 80 2 20 3 0

4 25 5 0 27 80 12 0 50 20 10 $825 $0 $825

825 14 965 825 0 1125 825 30 1250 825

0 1360 825 42 1465 5 0 53 28 5 0

64 0 Average Marginal Average Average Cost Cost Fixed Costs Variable (AC) (MC) (AFV) Costs (AFC + AVC) (q/L)TC/L)q/L)q) (FC/L)q) (AVC) (VC/L)q) Total

Cost (TC) (FC + VC) 14 $1.7 0 5 16 1.33 0 2.50 12

5.50 5 10.5 11 0 $10.3 $1.7 $12.0 1 5

6 4.13 1.50 5.63 3.30 1.70 5.00 3.06 1.98 5.04 2.95

2.29 5.24 0 10 5 Copyright 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Attempt the worksheet. Work in groups of two! Next week Quiz on Economic Profit/ Accounting Profit/Opportunity Cost, NEXT WEEK (15-20 min quiz)

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