# CHAPTER 07 - PHALL-82241 PINDYCK CHAPTER 07 page 5 of 20...

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Unformatted text preview: PHALL-82241 PINDYCK CHAPTER 07 page 5 of 20 FIGURE 7.1 Cost Curves for a Firm TC Cost 400 (dollars per year) 300 VC 175 A 100 FC 0 1 2 3 4 5 6 7 8 9 (a) 10 11 Output (units per year) Cost 100 (dollars per unit) 75 MC 50 ATC AVC 25 0 AFC 1 2 3 4 5 6 7 (b) 8 9 10 11 Output (units per year) In (a) total cost TC is the vertical sum of fixed cost FC and variable cost VC. In (b) average total cost ATC is the sum of average variable cost AVC and average fixed cost AFC. Marginal cost MC crosses the average variable cost and average total cost curves at their minimum points. Fig 07-01.EPS PHALL-82241 PINDYCK CHAPTER 07 FIGURE 7.2 The Short-Run Variable Costs of Aluminum Smelting Cost (dollars per ton) 1300 MC 1200 1140 AVC 1100 300 600 900 Output (tons per day) The short-run average variable cost of smelting is constant for output levels using up to two labor shifts. When a third shift is added, marginal cost and average variable cost increase until maximum capacity is reached. Fig 07-02.EPS page 6 of 20 PHALL-82241 PINDYCK CHAPTER 07 page 7 of 20 FIGURE 7.3 Producing a Given Output at Minimum Cost Capital per year K2 A K1 K3 q1 C0 L2 L1 C1 C2 L3 Labor per year Isocost curves describe the combination of inputs to production that cost the same amount to the firm. Isocost curve C1 is tangent to isoquant q1 at A and shows that output q1 can be produced at minimum cost with labor input L1 and capital input K1. Other input combinations-L2, K2 and L3, K3-yield the same output but at higher cost. Fig 07-03.EPS PHALL-82241 PINDYCK CHAPTER 07 page 8 of 20 FIGURE 7.4 Input Substitution When an Input Price Changes Capital per year B K2 A K1 q1 C2 L2 L1 C1 Labor per year Facing an isocost curve C1, the firm produces output q1 at point A using L1 units of labor and K1 units of capital. When the price of labor increases, the isocost curves become steeper. Output q1 is now produced at point B on isocost curve C2 by using L2 units of labor and K2 units of capital. Fig 07-04.EPS PHALL-82241 PINDYCK CHAPTER 07 page 9 of 20 FIGURE 7.5 The Cost-Minimizing Response to an Effluent Fee Capital D (machinehours per month) 5000 F 4000 3500 B 3000 A 2000 1000 Output of 2000 Tons of Steel per Month E 5000 10,000 12,000 C 18,000 20,000 Wastewater (gallons per month) When the firm is not charged for dumping its wastewater in a river, it chooses to produce a given output using 10,000 gallons of wastewater and 2000 machine-hours of capital at A. However, an effluent fee raises the cost of wastewater, shifts the isocost curve from FC to DE, and causes the firm to produce at B-a process that results in much less effluent. Fig 07-05.EPS PHALL-82241 PINDYCK CHAPTER 07 page 10 of 20 FIGURE 7.6 A Firm’s Expansion Path and Long-Run Total Cost Curve Capital per year 150 100 \$3000 Isocost Line Expansion Path \$2000 Isocost Line C 75 B 50 25 300 Unit Isoquant A 50 200 Unit Isoquant 100 150 200 300 Labor per year (a) Cost (dollars per year) F 3000 E 2000 1000 Long-Run Total Cost D 100 200 300 Output (units per year) (b) In (a), the expansion path (from the origin through points A, B, and C) illustrates the lowest-cost combinations of labor and capital that can be used to produce each level of output in the long run-i.e., when both inputs to production can be varied. In (b), the corresponding long-run total cost curve (from the origin through points D, E, and F) measures the least cost of producing each level of output. Fig 07-06.EPS PHALL-82241 PINDYCK CHAPTER 07 page 11 of 20 FIGURE 7.7 The Inflexibility of Short-Run Production Capital per E year C Long-Run Expansion Path A K2 P K1 Short-Run Expansion Path q2 q1 L1 L2 B L3 D F Labor per year When a firm operates in the short run, its cost of production may not be minimized because of inflexibility in the use of capital inputs. Output is initially at level q1. In the short run, output q2 can be produced only by increasing labor from L1 to L3 because capital is fixed at K1. In the long run, the same output can be produced more cheaply by increasing labor from L1 to L2 and capital from K1 to K2. Fig 07-07.EPS PHALL-82241 PINDYCK CHAPTER 07 page 12 of 20 FIGURE 7.8 Long-Run Average and Marginal Cost Cost (dollars per unit of output) LMC LAC A Output When a firm is producing at an output at which the long-run average cost LAC is falling, the long-run marginal cost LMC is less than LAC. Conversely, when LAC is increasing, LMC is greater than LAC. The two curves intersect at A, where the LAC curve achieves its minimum. Fig 07-08.EPS PHALL-82241 PINDYCK CHAPTER 07 page 13 of 20 FIGURE 7.9 Long-Run Cost with Economies and Diseconomies of Scale Cost (dollars per unit of output) \$10 SMC 1 \$8 A B SAC 1 SAC 2 SMC 3 SAC 3 LAC SMC 2 LMC q0 q1 q2 q3 The long-run average cost curve LAC is the envelope of the short-run average cost curves SAC1, SAC2, and SAC3. With economies and diseconomies of scale, the minimum points of the short-run average cost curves do not lie on the long-run average cost curve. Fig 07-09.EPS Output PHALL-82241 PINDYCK CHAPTER 07 page 14 of 20 FIGURE 7.10 Product Transformation Curve Number of tractors O2 O1 0 Number of cars The product transformation curve describes the different combinations of two outputs that can be produced with a fixed amount of production inputs. The product transformation curves O1 and O2 are bowed out (or concave) because there are economies of scope in production. Fig 07-10.EPS PHALL-82241 PINDYCK CHAPTER 07 page 15 of 20 FIGURE 7.11 The Learning Curve Hours of labor per machine lot 8 6 4 2 0 10 20 30 40 50 Cumulative number of machine lots produced A firm’s production cost may fall over time as managers and workers become more experienced and more effective at using the available plant and equipment. The learning curve shows the extent to which hours of labor needed per unit of output fall as the cumulative output increases. Fig 07-11.EPS PHALL-82241 PINDYCK CHAPTER 07 page 16 of 20 FIGURE 7.12 Economies of Scale versus Learning Cost (dollars per unit of output) A Economies of Scale B Learning AC 1 C AC 2 Output A firm’s average cost of production can decline over time because of growth of sales when increasing returns are present (a move from A to B on curve AC1), or it can decline because there is a learning curve (a move from A on curve AC1 to C on curve AC2). Fig 07-12.EPS PHALL-82241 PINDYCK CHAPTER 07 page 17 of 20 FIGURE 7.13 Learning Curve for Airbus Industrie Relative 100 production hours per aircraft 80 60 40 Average for First 100 Aircraft Average for First 500 Aircraft 20 0 0 100 200 300 400 500 Number of aircraft produced The learning curve relates the labor requirement per aircraft to the cumulative number of aircraft produced. As the production process becomes better organized and workers gain familiarity with their jobs, labor requirements fall dramatically. Fig 07-13.EPS PHALL-82241 PINDYCK CHAPTER 07 FIGURE 7.14 Variable Cost Curve for the Automobile Industry Variable cost • General Motors •Toyota Honda Volvo • • Nissan • • Ford • Chrysler Quantity of cars An empirical estimate of the variable cost curve can be obtained by using data for individual firms in an industry. The variable cost curve for automobile production is obtained by determining statistically the curve that best fits the points that relate the output of each firm to the firm’s variable cost of production. Fig 07-14.EPS page 18 of 20 PHALL-82241 PINDYCK CHAPTER 07 page 19 of 20 FIGURE 7.15 Cubic Cost Function Cost (dollars per unit of output) MC = ß + 2γ q + 3δq2 AVC = ß + γ q + δ q2 Output (per time period) A cubic cost function implies that the average and the marginal cost curves are U-shaped. Fig 07-15.EPS PHALL-82241 PINDYCK CHAPTER 07 page 20 of 20 FIGURE 7.16 Average Cost of Production in the Electric Power Industry Average cost (dollars per 1000 6.5 kwh) 6.0 1955 A 5.5 5.0 1970 6 12 18 24 30 36 Output (billion kwh) The average cost of electric power in 1955 achieved a minimum at approximately 20 billion kilowatt-hours. By 1970 the average cost of production had fallen sharply and achieved a minimum at an output of more than 33 billion kilowatt-hours. Fig 07-16.EPS ...
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