Friday, May 30, 2014

I found a Microeconomics Unicorn! See the chart here.

A rare treat for an economics teacher.  A chart that quantifies (not completely but enough) the difference between "Economic Costs" which include opportunity costs (implicit costs) as well as money costs (explicit costs), and "Accounting Costs" which include ONLY money costs. 

Source: USDA ERS

Costs of production for U.S. milk decline as the size of the dairy operation (measured by the number of cows) increases.  Based on 2013 data, average total economic costs of milk production—a measure that includes the opportunity costs of land, labor, and other owned resources—fell by nearly 60 percent, from an average of about $50 per hundredweight (cwt) for producers with fewer than 50 cows to about $20 per cwt for those with 1,000 cows or more. Average costs are lower on larger farms because fixed cost items, such as management, land, and other resource costs, are spread across a larger number of cows, and because average output per cow increases along with farm size. Mean output per cow was just over 15,000 pounds among operations with less than 50 cows, while operations with 1,000 or more head averaged more than 23,000 pounds per cow. Higher milk yields on larger farms stem from factors such as better breeding, nutrition, and health management, as well as the ability to access competitively priced supplies of high quality feed inputs.  This chart is based on data found in Milk Cost of Production Estimates.
 

This is a key concept in AP Microeconomics that is somewhat difficult to convey to high school aged students.

The vertical difference between the RED and BLUE lines represents the Opportunity Costs to the producer for staying in business.

The price or Marginal Revenue (MR) or Average Revenue (AR), a producer receives must at least equal the RED line for her to "Break Even".  

However, she could still make an Accounting Profit at that price.  Is she?

According to the USDA ERS (HERE) the average price for "all classes of milk" was $20.05 per CWT) in 2013.  Now look back at the graph and draw a straight line across the $20.00 mark denoted on the vertical axis.  Compare that to the RED and BLUE lines.

At that price ONLY the large producers (1000 or more milk cows) are Breaking Even in "Economic" terms BUT making profit in "Accounting" terms.

Notice at about 300 cows the average costs start to drop at a relatively steep rate and production increases quickly.  I assume that is the inflection point where economies of scale really kick in.

Hope this helps with teaching and/or learning about this important concept when the topic of a firm that operates in a "Perfectly Competitive" market.

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