Transcript Economic Profit and Economies of Scale

Economic Profit,
Production and
Economies of Scale
By the end of this Section you
should be able to:

Calculate and define:
2
kinds of Profit

2 kinds of associated costs
 Production
Total Product (TP)
 Marginal Product (MP)

Increasing, decreasing and negative marginal returns
 Discuss and apply the Law of Diminishing Marginal
Product


Average Product (AP)
Profit
Firm’s main goal is to maximize profit.
 Profit is defined as Total Revenue (TR)
minus Total Cost (TC).

 TR=price*quantity=PQ
 TC
– we will talk about this in the next section
Costs

There exists two types of costs:
 Explicit
Cost: A Cost paid in Money.
 Implicit Cost: Expenses an owner does not
have to pay out of pocket, such as
Opportunity Cost, Owner Provided Capital (K),
and Owner Provided Labor (L).

These two types of costs yield 2 types of
Profits.
Types of Profit

Accounting Profit: looks at revenue as
money taken in and costs as the money it
takes to produce things.
 Defines

Total Costs as explicit costs.
Economic Profit: looks at revenue as
money taken in and costs as the money it
takes to produce things and expenses an
owner does not payout of pocket.
 Defines
costs.
Total Costs as explicit and implicit
Example of Types of Profit

Suppose Sam owns a smoothie shop:
 TR:
$150,000
 Explicit Costs:


Cost of fruit and yogurt: $20,000
Cost of wages: $22,000
 Implicit Costs:
 Sam’s forgone wages (owning a smoothie shop and not
working somewhere else): $34,000

Accounting Profit:
 TR

– EC = 150,000-20,000-22,000 = 108,000
Economic Profit:
 TR
– EC – IC = 150,000-42,000-34,000 = 74,000
Production

The relationship between output and
quantity of labor is described by total
product, marginal product and average
product.
Total Product

Total Product is the total quantity of a
good provided in a given period.
 It
defines the total amount that can be
produced in a period of time given the number
of workers.
 So we look at production possibilities with a
set number of workers.
Marginal Product
Marginal Product is the change in total
product due to a one unit increase in the
amount of labor employed.
 MP=
TP

Gallons per
Additional
Worker
0
Labor
Increasing Marginal Returns
Decreasing Marginal Returns
Negative Marginal Returns
Quantity
of Labor
So we look at how the total product changes while the amount of labor changes.
Increasing Marginal Returns

Increasing Marginal Returns is when the
marginal product of an additional worker
exceeds the marginal product of the previous
worker.
 When
there are few workers, they can’t get everything
done. As you hire more workers, the work gets done
(there is an increase in quantity produced).

As the number of workers increases, the total
amount produced increases and the production
per worker increases too.
Decreasing Marginal Returns

Decreasing Marginal Returns is when the
marginal product of an additional worker is less
than the marginal product (MP) of the previous
worker.
 Each
additional worker is not helping as much as the
previous worker, but they do help and positively
increase output.

As the number of workers increases, the total
amount produced increases but the amount
produced per worker decreases.
Negative Marginal Returns

Negative Marginal Returns is when an additional
person decreases the amount of quantity
produced.
 Too
many cooks in the Kitchen, New Workers
Distract, etc.


As the number of workers increases, both the
amount of production decreases and the amount
of production per worker decreases.
The type of return (Increasing, Decreasing or
Negative) is determined by the slope of the total
product line.
Law of Diminishing Returns
•
•
The law of diminishing returns:
as successive units of a variable resource
are added to a fixed resource, the marginal
product of the variable resource will
eventually decline.
Because there are fixed things (plant size) in
the short run, increasing variable inputs such
as labor will lead to diminishing returns.
Average Product
Average Product (AP) is the general
productivity of each worker.
 AP =
TP
Q of Labor
