CH. 11: OUTPUT AND COSTS

Measure of relationship between output and costShort run costsFixed vs variableCost curvesLaw of diminishing marginal returnsLong run costsNo fixed costsCost curvesReturns to scale

Short run vs. Long runThe Short RunA time frame in which one or more resources used in production is fixed.For most firms, capital is fixed in the short run.Other resources used by the firm (such as labor, raw materials, and energy) are variable in the short run.Short-run decisions are easily reversed.The Long RunA time frame in which the quantities of all resources can be varied.No fixed inputs in the long run.

Decision Time FramesSunk Costs. A cost incurred by the firm that cannot be changed. If a firms plant has no resale value, the amount paid for it is a sunk cost. Sunk costs are irrelevant to a firms decisions .Examples: The price that a landlord paid for a piece of property should have no effect on rent charged. The price that an airline paid for jets that it purchased previously should have no effect on the price they charge for airline tickets today.

SR Measures of ProductionTotal product (TP) Units of output produced in a given period.Marginal product of labor (MPL) D TP resulting from one additional unit of L, ceteris paribus. DTP/DLAverage product of labor (APL) TP/L

Relationship between TP, MP and APThe Total Product Curve

Relationship between TP, MP and APThe Total Product Curve

Relationship between TP, MP and APAlmost all production processes are like the one shown here and have:Initially increasing marginal returnsEventually diminishing marginal returns

Relationship between TP, MP and APIncreasing marginal returns MP rises as use of input increasesResults from increased specialization and division of labor.Diminishing marginal returns MP falls as use of input increasesOccurs because amount of capital per worker falls. The law of diminishing returns As a firm uses more of a variable input with a given quantity of fixed inputs, the marginal product of the variable input eventually diminishes.

Short-Run Technology Constraint IF MP>AP, what happens to AP if L is increased?If MP

SR CostTotal cost (TC) is the cost of all resources used.Total fixed cost (TFC) is the cost of the firms fixed inputs. Fixed costs do not change with output.Total variable cost (TVC) is the cost of the firms variable inputs. Variable costs do change with output.TC = TFC + TVC

SR Total Cost Curves

SR CostsMarginal Costthe increase in total cost that results from a one-unit increase in total product.DTC/DTPIf labor is the only variable input, MC=W/ MPLOver the output range with increasing marginal returns, marginal cost falls as output increases.Over the output range with diminishing marginal returns, marginal cost rises as output increases.

SR CostsAverage CostsAverage fixed cost (AFC) = TFC/TPAverage variable cost (AVC) = TVC/TPIf labor is the only variable input, AVC=W/APLAverage total cost (ATC) is total cost per unit of output.ATC = TC/TP = AFC + AVC.

SR CostsMarginal vs. AVC and ATCIf MCAVC, AVC increases as TP increases

If MCATC, ATC increases as TP increases

SR Cost CurvesThe ATC curve is U-shaped.If MCAVC, AVC is rising.MC always interesectsATC at min of ATCAVC at min of AVCAFC always decreases as output increases

.

Relationship between production and cost

Short-Run CostShifts in Cost CurvesThe position of a firms cost curves depend on two factors: Technology Prices of productive resourcesWhat is effect on ATC, MC, AVC ofIncrease in price of labor.Increase in fixed costs Increase in productivity of labor.

Fill in the table below

TPTCTFCTVCATCAVCMC010011502190324043005400

Long-Run CostIn the long run, all inputs are variable and all costs are variable. The Production FunctionShows the relationship between the maximum output attainable and the quantities of both capital and labor.

Long-Run CostMarginal product of capital (MPk)the increase in TP from one more unit of capital, ceteris paribus. A firms production function exhibits diminishing marginal returns to labor as well as diminishing marginal returns to capital (for a given quantity of labor).For each plant size, diminishing marginal product of labor creates a set of short run, U-shaped costs curves for MC, AVC, and ATC.

LR CostWhats the low cost method for producing 5 sweaters? 13 sweaters? 25 sweaters?The long-run average cost curve is the relationship between the lowest attainable average total cost and output when both the plant size and labor are varied.

K=1K=2K=3K=4

LR CostThe long-run average cost (LRAC) curve.

LR CostEconomies of scale falling long-run average cost as output increases.Diseconomies of scale rising long-run average cost as output increases.Constant returns to scale constant long-run average cost as output increases.

Long-Run Cost

Long-Run CostMinimum efficient scale is the smallest quantity of output at which the long-run average cost reaches its lowest level.

LRATCMES

Market Structure and Minimum Efficient ScaleAs MES rises relative to consumer demand, the number of firms in the industry will fall. Cases to consider:MicrosoftSteel industryPrinting industryFarming

************************