2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed. c c h h a a p p t t e e r rtentenPrepared by: Fernando & Yvonn QuijanoTechnology, Production,and Costs 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and Costs After studying this chapter, you should be able to:Define technology and give examples of positive and negative technological change.Distinguish between the economic short run and the economic long run.Understand the relationship between the marginal product of labor and the average product of labor. Explain and illustrate the relationship between marginal cost and average total cost.Graph average total cost, average variable cost, average fixed cost, and marginal cost.Understand how firms use the long-run average cost curve to plan.Sony Uses a Cost Curve to Determine the Price of RadiosLEARNING OBJECTIVES12345In this chapter, we will focus on the relationship between a firms technology and its production costs.62 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsTechnology: An Economic DefinitionLEARNING OBJECTIVE1Technology The processes a firm uses to turn inputs into outputs of goods and services. Technological change A change in the ability of a firm to produce a given level of output with a given quantity of inputs.3 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsImproving Inventory Control at Wal-Mart10 - 1Better inventory controls have helped reduce firms costs.4 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Short Run and the Long RunShort run The period of time during which at least one of the firms inputs is fixed. Long run A period of time long enough to allow a firm to vary all of its inputs, to adopt new technology, and to increase or decrease the size of its physical plant.LEARNING OBJECTIVE25 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Short Run and the Long RunThe Difference between Fixed Costs and Variable CostsTotal cost The cost of all the inputs a firm uses in production. Variable costs Costs that change as output changes.Fixed costs Costs that remain constant as output changes.Total Cost = Fixed Cost + Variable CostTC = FC + VC6 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsFixed Costs in the Publishing Industry10 - 2COSTAMOUNTSalaries and BenefitsRentUtilitiesSuppliesPostageTravelSubscriptions, etc.MiscellaneousTotal$437,500$75,000$20,000$6,000$4,000$8,000$4,000$5,000$559,500The salaries of editors are considered a fixed cost by publishers.7 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Short Run and the Long RunImplicit versus Explicit CostsOpportunity cost The highest-valued alternative that must be given up to engage in an activity. Explicit cost A cost that involves spending money.Implicit cost A nonmonetary opportunity cost.8 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Short Run and the Long RunThe Production Function Jill Johnsons Costs per Year10 1PaperWagesLease payment for copy machinesElectricityLease payment for storeForegone salaryForegone interestTotal$20,000$48,000$10,000$6,000$24,000$30,000$3,000$141,000Production Function The relationship between the inputs employed by the firm and the maximum output it can produce with those inputs.9 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Short Run and the Long RunA First Look at the Relationship Between Production and CostShort-Run Production and Cost at Jill Johnsons Copy Store10 2QUANTITY OF WORKERSQUANTITY OF COPY MACHINESQUANTITY OF COPIESCOST OF COPY MACHINES (FIXED COST)COST OF WORKERS (VARIABLE COST)TOTAL COST OF COPIESCOST PER COPY (AVERAGE COST)01234562222222062513252200260029003100$25252525252525$050100150200250300$2575125175225275325-$0.120.090.080.090.100.11Average total cost Total cost divided by the quantity of output produced.10 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Short Run and the Long RunA First Look at the Relationship Between Production and Cost10 - 1Graphing Total cost and Average Total Cost at Jill Johnsons Photocopy Store11 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Marginal Product of Labor and the Average Product of LaborLEARNING OBJECTIVE3Marginal product of labor The additional output a firm produces as a result of hiring one more worker.The Law of Diminishing ReturnsLaw of diminishing returns The principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable to decline.12 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Law of Diminishing ReturnsQUANTITY OF WORKERSQUANTITY OF COPY MACHINESQUANTITY OF COPIESMARGINAL PRODUCT OF LABOR0123456222222206251,3252,2002,6002,9003,100-625700875400300200Marginal and Average Product of Labor at Jill Johnsons Copy Store10 3The Marginal Product of Labor and the Average Product of Labor13 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsGraphing Production10 - 2Total Output and the Marginal Product of LaborThe Marginal Product of Labor and the Average Product of Labor14 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsAdam Smiths Famous Account of the Division of Labor in a Pin Factory10 - 3The gains from division of labor and specialization are as important to firms today as they were in the eighteenth century when Adam Smith first discussed them.15 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Relationship between Marginal and Average ProductAverage product of labor The total output produced by a firm divided by the quantity of workers.The Marginal Product of Labor and the Average Product of Labor16 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsAn Example of Marginal and Average Values: College Grades10 - 3Marginal and Average GPAsThe Marginal Product of Labor and the Average Product of Labor17 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Relationship Between Short-Run Production and Short-Run CostLEARNING OBJECTIVE4Marginal CostMarginal Cost The change in a firms total cost from producing one more unit of a good or service.18 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsWhy Are the Marginal and Average Cost Curves U-Shaped?10 - 4Jill Johnsons Marginal Cost and Average Cost of Producing CopiesThe Relationship Between Short-Run Production and Short-Run Cost19 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and Costs The Relationship Between Marginal and Average Cost10 - 1LEARNING OBJECTIVE420 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsGraphing Cost CurvesAverage fixed cost Fixed cost divided by the quantity of output produced.Average variable cost Variable cost divided by the quantity of units produced.Average total cost = ATC = TC/QAverage fixed cost = AFC = FC/QAverage variable cost = AVC = VC/QATC = AFC + AVCLEARNING OBJECTIVE521 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsGraphing Cost Curves10 - 5Costs at Jill Johnsons Copy Store 22 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsCosts in the Long RunLEARNING OBJECTIVE6Economies of ScaleLong-run average cost curve A curve showing the lowest cost at which the firm is able to produce a given quantity of output in the long run, when no inputs are fixed.Economies of scale Economies of scale exist when a firms long-run average costs fall as it increases output.23 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsCosts in the Long RunEconomies of ScaleConstant returns to scale Constant returns to scale exist when a firms long-run average costs remain unchanged as it increases output.Minimum efficient scale The level of output at which all economies of scale have been exhausted.Diseconomies of scale Exist when a firms long-run average costs rise as it increases output.24 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsCosts in the Long RunLong-Run Average Total Cost Curves for Bookstores10 - 6The Relationship between Short-Run Average Cost and Long-Run Average Cost25 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and Costs Using Long-Run Average Cost Curves to Understand Business Strategy10 - 2LEARNING OBJECTIVE626 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Colossal River Rouge: Diseconomies of Scale at the Ford Motor Company10 - 4Is it possible for a factory to be too big?27 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsDont Confuse Diminishing Returns with Diseconomies of Scale28 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsConclusionA Summary of Definitions of Cost10 4TERMDEFINITIONSYMBOLS AND EQUATIONSTotal costThe value of all the inputs used by a firmTCFixed costCosts that remain constant when a firms level of output changesFCVariable costCosts that change when the firms level of output changesVCMarginal costThe increase in total cost resulting from producing another unit of outputAverage total costTotal cost divided by the quantity of units producedAverage fixed costFixed cost divided by the quantity of units producedAverage variable costVariable cost divided by the quantity of units producedImplicit costA nonmonetary opportunity cost-Explicit costA cost that involves spending money-29 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsIts Win-Win as Samsung, Sony Join on Flat Screens30 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsAN INSIDE LOOKSony Gambles on the FutureCost of the Next Generation of TVsEconomies of scale will result in a lower average total cost of production in 2013 if Sony can sell 2.8 million OLED TVs.31 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsAverage fixed costAverage variable costAverage product of laborAverage total costConstant returns to scaleDiseconomies of scaleEconomies of scaleExplicit costFixed costsImplicit costLaw of diminishing returnsLong runLong-run average cost curveMarginal costMarginal product of laborMinimum efficient scaleOpportunity costProduction functionShort runTechnological changeTechnologyTotal costVariable costs32 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsAppendix 10A: Using Isoquants and Isocosts to Understand Production and CostIsoquantsAn Isoquant GraphIsoquant A curve showing all the combinations of two inputs, such as capital and labor, that will produce the same level of output.33 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsIsoquantsThe Slope of an IsoquantMarginal rate of technical substitution (MRTS) The slope of an isoquant; represents the rate at which a firm is able to substitute one input for another, while keeping the level of output constant.10A - 1IsoquantsAppendix 10A: Using Isoquants and Isocosts to Understand Production and Cost34 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsIsocost LinesIsocost line All the combinations of two inputs, such as capital and labor, that have the same total cost.Appendix 10A: Using Isoquants and Isocosts to Understand Production and Cost35 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsIsocost LinesThe Slope and Positionof the Isocost Line10A - 2The Isocost LineAppendix 10A: Using Isoquants and Isocosts to Understand Production and Cost36 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsChoosing the Cost-Minimizing Combination of Capital and Labor10A - 3The Position of the Isocost Line 10A - 4Choosing Capital and Labor to Minimize Total CostAppendix 10A: Using Isoquants and Isocosts to Understand Production and Cost37 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsChoosing the Cost-Minimizing Combination of Capital and LaborDifferent Input Price Ratios Lead to Different Input Choices10A - 5Changing Input Prices Affects the Cost-Minimizing Input ChoiceAppendix 10A: Using Isoquants and Isocosts to Understand Production and Cost38 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Changing Input Mix in Film AnimationA change in the price of labor relative to capital in the production of animated films led to a large reduction in the employment of animators.10A - 139 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsChoosing the Cost-Minimizing Combination of Capital and LaborAnother Look at Cost MinimizationAppendix 10A: Using Isoquants and Isocosts to Understand Production and Cost40 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and Costs Determining the Optimal Combination of Inputs10A -1Marginal Product of CapitalMarginal Product of LaborWage rateRental price of machines3000 copies100 copies$50 per day$600 per day41 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsThe Expansion PathExpansion path A curve showing a firms cost-minimizing combination of inputs for every level of output.10A - 6The Expansion PathAppendix 10A: Using Isoquants and Isocosts to Understand Production and Cost42 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick OBrien1st ed.CHAPTER 10: Technology, Production,and CostsExpansion pathIsocost line IsoquantMarginal rate of technical substitution (MRTS)43