1. Organize factors of production and/or2. Produce goods and services and/or3. Sell produced goods and services

• A virtual firm organizes production and subcontracts out all work

• Many of the organizational structures of business are being separated from the

production process

explicit

implicit (opportunity)

total

economic

normal

accounting

The factory size can change

Long Run

Factors like labor and raw materials can be changed

Short Run:

laborraw materials

• Long run and short run do not necessarily refer to specific periods of time, but to the flexibility the firm has

in changing the level of output

The least cost combination of inputs.

Efficient Production

The recipe: going from inputs to outputs

It varies by firm

Labor Total Marginal AverageData: Output

0 01 32 83 124 155 176 18

___

______

___

______

35432

1

______

___

______

3443.75

3.4___3

Output

Quantity of Labor

18

15

12

9

6

3

1 2 3 4 5 60

Total Output

Output

Quantity of Labor

6

5

4

3

2

1

1 2 3 4 5 60

Average and Marginal

Like Labor

In the beginning, output increases with each unit added, but at some point output will begin to decrease

with each additional unit of a resource.

The Law of Diminishing Returns

Labor Total Marginal AverageData: Output

0 01 32 83 124 155 176 18

___

______

___

______

35432

1

______

___

______

3443.75

3.4___3

Increasing marginal

productivityDiminishing

marginal productivity

DiminishingAbsolute

productivity

Total Fixed Costs

Do change with output

Do not change with output

Total Variable CostsTotal Costs = TFC + TVC

rent

bourbon scotch beer

Average Fixed Costs

Do change with outputDo not change with output

Average Variable CostsAverage Total Costs = ?+?Marginal CostChange in cost with 1 more

output

She produces these in her own home without any help, unless she has a large number of orders on a

particular day.

Marcia Deal bakes and decorates large, elaborate,

multi-layered, special occasion cakes.

# TC TFC TVC ATC MC

0

1

2

3

4

5

6

7

8

With the following information, complete the table:

The total cost of producing 5 cakes is $135Marcia’s total fixed cost for 1 cake is $25

The total cost of 2 cakes is $60

The total variable cost for 1 cake is $25

The total variable cost of producing 7 cakes is $220The marginal cost of the 6th cake is $45

The marginal cost for the 8th cake is $91The ATC per cake when 3 cakes or when 4 cakes are made is $25

Why is the Marginal Cost of the 7th and 8th cakes fairly high?

If Marcia can sell from 0 - 8 cakes at $40 each, how many will she choose to

produce and sell per day if she is trying to maximize her profits??

On the graph, plot the average total cost and marginal cost of producing

from 0 – 8 cakes.Plot the marginal cost at the

midpoints

$120

110

100

90

80

70

60

50

40

30

20

10

01 2 3 4 5 6 7 8 Number of

Cakes

Avera

ge T

ota

l C

ost

and M

arg

inal C

ost

Graph Marcia’s ATC, MC and MR

$120

110

100

90

80

70

60

50

40

30

20

10

01 2 3 4 5 6 7 8 Number of

Cakes

Avera

ge T

ota

l C

ost

and M

arg

inal C

ost

Graph Marcia’s ATC, MC and MR

Number of Cakes

Total Revenue

Total CostTotal Profit

Marginal Revenue

Marginal Cost

0

1

2

3

4

5

6

7

8

$350

300

250

200

150

100

50

01 2 3 4 5 6 7 8 Number of

Cakes

Tota

l C

ost

Graph Marcia’s TC, TFC and TVC

$350

300

250

200

150

100

50

01 2 3 4 5 6 7 8 Number of

Cakes

Tota

l C

ost

Graph Marcia’s TC, TFC and TVC

Output TFC TVC TC0 100 0 1 50

2 90

3 120

4 160

5 220

6 300

7 400

8 5209 670

10 900

______

___

___

___

___

____________

100

100

100

100

100

100

100

100

100

100

100

150

190

220

260

320

400

500

620

770

1000

______

___

___

___

___

____________

Output AFC AVC ATCMC0 (TFC/output) (TVC/output) (TC/output) (TC1-TC0)

1 ________ ________ ________ _____

2 ____________ ____________ ____________ _______

3 ____________ ____________ ____________ _______

4 ____________ ____________ ____________ _______

5 ____________ ____________ ____________ _______

6 ____________ ____________ ____________ _______

7 ____________ ____________ ____________ _______

8 ____________ ____________ ____________ _______

9 ____________ ____________ ____________ _______

10 ____________ ____________ ____________ _______

1

2

3

4

5

6

7

8

9

10

100

50

33

25

20

17

14

12

11

10

50

45

40

40

44

50

59

65

74

90

150

95

73

65

64

67

73

78

85

100

50

40

30

40

60

80

100

120

150

230

Cost

Output

600

500

400

300

200

100

1 2 3 4 5 60 7 8 9 10

Total Variable Cost

Total Fixed Cost

Total Cost

700

800

900

Cost

Output

60

50

40

30

20

10

1 2 3 4 5 60

Graphed

7 8 9 10

70

80

90

and

The Relationship Between Marginal Productivity and Marginal Costs

AVC

Q

MC

Q

Output per worker

Costs per unit

If marginal productivity is rising, marginal costs are falling

If average productivity is falling, average costs are rising

MP of workers

AP of workers

12-24

• If MC > ATC, then ATC is rising

• If MC > AVC, then AVC is rising

• If MC < ATC, then ATC is falling

• If MC < AVC, then AVC is falling

• If MC = AVC and MC = ATC, then AVC and ATC are at their minimum points

The Relationship Between Marginal Cost and Average Cost

12-25

The Relationship Between Marginal Cost and Average Cost

AVC

MC

Q

Costs per unit

ATCThe marginal cost curve

goes through the minimum point of both the ATC and AVC curves

12-26

1. Which of the following is most likely to be an implicit cost of production?

a. property taxes on a building owned by the firmb. transportation costs paid to a trucking supplierc. rental payments for a building utilized by the company and rented

from another partyd. interest income foregone on funds invested in the firm by the

owners

2. The law of diminishing returnsa. explains why marginal cost eventually increases as output expands.b. implies that average fixed cost will remain unchanged as output expands.c. is true for physical production activities but not for activities such as studying.d. applies to a capitalist economy but would be irrelevant if the means of production were owned by the state.

3. Which of the following represents a long-run adjustment?a. the hiring of four additional cashiers by a supermarketb. a cutback on purchases of coke and iron ore by a steel manufacturerc. construction of a new assembly-line plant by a car manufacturerd. the extra dose of fertilizer used by a farmer on his wheat crop

4. The short-run average total cost (ATC) curve of a firm is U-shaped becausea. larger firms always have lower per-unit costs than smaller firms.b. at low levels of output, AFC will be high, while at high levels of output, MC will be high as the result of diminishing returns.c. diminishing returns will be present when output is small, and high AFC will push per-unit cost to high levels when output is large.d. diseconomies of scale will be present at both small and large output rates.

5. When costs that vary with the level of output are divided by the output, you have calculated

a. total changing cost. b. total fixed cost.c. average fixed cost. d. average variable cost.

6. In the short run, if average variable cost equals $50, average total cost equals $75, and output equals 100, the total fixed cost must be a. $25. b. $2,500. c. $5,000. d.$7,500.

At what output in the graph would the firm’s per-unit cost of production be minimized?a.3 b. 4 c. 5 d. 6What is the firm’s approximate total cost when it produces three units?a.10 b. 16 c. 48 d. 60

What is the firm’s total cost when it produces four units?a.11 b. 15 c. 60 d. 75 The average variable cost and average

total cost for a firm are indicated in the graph. If the marginal cost curve were constructed, at what output would it cross the AVC curve?a. 10 b. 15 c. 20 d.

25At what output should a the marginal cost curve cross the ATC curve?a. 15 b. 20 c. 25 d.

30

b. 4

c. 48

c. 60

b. 15

b. 20