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Short-run Cost of Production

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Short-run Cost of Production

The Production Process: How Firms Convert Inputs into Final Outputs.

In order to maximize profits, firms must ensure that any given output level is produced at least cost and then select the price-output combination that results in total revenue exceeding total cost by the greatest amount possible. With this in mind, this second module of the Power of Markets course addresses how firms can most effectively convert inputs into final output and then covers determining the best price-output combination for a firm and how this varies depending on whether the firm is operating in a perfectly competitive or imperfectly competitive market setting.

Taught By

Mark Zupan
Professor of Economics and Public Policy

Transcript

In the last session, we covered returns to scale.

let me give you a few other examples from everyday life.

When we look at fast food and es, especially the fresh fast fresh segments

that have been developing with outfits like

Five Guys and In and Out and Chipotle.

And what Chipotle does, by dividing labor, a

certain person does something with the burrito you've ordered.

Another person adds this

ingredient to the mix. Another person is at the cashier stand.

There are advantages in productivity.

One of the advantages Chipotle also has is how do

you be able to take advantage of large scale production techniques.

Their barbacoa, the certain types of meats they

mass produce at a central location in Chicago.

But through this elaborate cooking

technique called suvita, that formerly used

to be owned, used to be performed only by top chefs at the very best

restaurants in the country. And through this technique, meat is placed

in a airtight package with certain spices, and cooked

in a, in a water vat to a particular temperature, and then shipped

out to the different Chipotle locations. And then it's this meat's

been can be applied to the different products that Chipotle puts out.

A very basic worker can run this production process.

Historically it took a very experienced chef to pull

this off at one of, at a high class restaurant.

Chipotle's figured out a way to mass produce

this and achieve the same level of quality.

By again, promoting division of labor and using a large scale

production technique. Another example is trade flows.

It's been observed that let's say car production or aircraft production.

Why do companies in several different countries produce cars?

like Sweden or Germany or Japan or the United States.

Or, in case of aircraft production, why do we have large scale production by both

Airbus and Boeing?

Traditional models had looked at particular countries relatively

good at producing one product versus the other.

what Paul Krugman, an economist who won the

Nobel Prize and now writes frequently for the New

York Times, won the prize for, is by saying

there are two factors that drive these trade flows.

First is diversity of preferences. some people prefer

more safety in their cars and will end up buying Volvo's.

And will in particular focus their buying preferences from

companies that are located in countries that produce safer cars.

Others maybe look for greater performance, and so cars produced from Germany.

And others may look for greater reliability, cars

that are produced in countries like Korea and Japan.

Then returns to scale Krugman argue, Krugman argues also matter.

Why has the European Union and the United

States ended up being the two largest aircraft producers?

And he points to a whole market effect giving an advantage to

companies like, Boeing and Airbus when they then end up competing globally.

Because the size of the US market is so

large it allowed Boeing to expand and to capture

the benefits for returns to scale, increasing

returns to scale like was with Airbus.

And that the significance of the whole market effect is what

ends up explaining which particular countries

when we look at international trade

flows end up being the dominant producers of automobiles when trade opens

up the ability of countries to sell to consumers in other countries.

Now, we're going to turn to chapter eight, and looking

at different costs, and different conceptions of cost in the short run.

In particular seven different measures of short

run cost; total fix cost, variable cost,

total cost, marginal cost, average fix cost,

average variable cost and average total cost.

Table 8.1 depicts the seven cost curves for different levels of output.

What we mean by total fixed cost is cost that you can't vary in the short run.

You're stuck with them.

They're not quite the same as sign cost that

we talked about in one of our early sessions.

Because conceivably some of the fixed cost associated with

your production plan, you still might be able to salvage.

But for all intents and purposes, we're going to end up

treating total fixed costs as being the same as sign cost.

Things that you can't vary in the short run.

And in the case of this particular table, you're

stuck with $60 no matter what output level you choose.

That's what total fixed cost is equal to.

Total variable costs are the costs that get

incurred, that get added when you increase output.

And then total cost is the sum of the two. So let's say of five units of

output, total fixed cost 60. Added to that $100 total variable cost.

Total cost is 160. Marginal cost is

the amount by which total cost goes up for each additional unit of output.

So let's look at the case of going from six units of output to seven.

Total costs go up by, by 26 units from $184 to $210, and that's why

marginal cost in that column is equal to $26 and an output level of seven.

Note that this is the same amount the total fixed cost, total

variable cost also go up, between six and seven units of output.

Because that's what driving the change in total cost.

Total fixed cost is constant.

The last three columns just are averages of the first three columns.

Average fixed cost is just total fixed cost divided by quantity.

so in the case of two units of output, we divide $60 by two units of output.

$30 is the average fixed cost at an output level of two.

Average variable

cost is total variable cost divided by quantity.

So at an output level of one, $30 is the

total variable cost divided by one, equals our average variable cost.

Average total cost is total cost divided by quantity.

And it is the sum of the average fixed cost and average variable cost.

So let's look at the case at five units of output

where average fixed cost is $12 per unit at that point, average variable cost

$20 per unit. The average total cost is the sum

of those two, is so $12, $20 $32 per unit at that point.

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