Output and Costs

Macroeconomic Foundation Alaleh Mani2011

Survival key of business

• Is not about its size :Garage, Convenience store, GM• Is how to produce to minimize the cost (P)• Is how much to produce(Q)• Is How soon to produce:

1. Short- run:2. Long run:

Depend on Market Structure

Short Run

At least one factor of production is fixed: Land, capital, entrepreneurship =firm’s Plant

are fixed but labor is variable (CFA 2009) To produce more in short run firms need to

increase its variable factor Short run are easily reversed

Long Run

A time frame that all factors of production are Variable Land, capital, entrepreneurship =firm’s Plant and

labor are variable To produce more in long run firms may increase the

plant or labor. Long run are not easily reversed Sunk Cost: Past expenditure with no resale value that

has no relation with current decision (CFA 2007-2010) Only Short run and long run decision influence on

current decision (exam 2008)

Short run production

• Relation between output and Labor (exam 2007)

Out

put p

er d

ay

Hours and minutes

Attainable Area Inefficient

Unattain

able

area Production Possibility Curve

Attainable Area

Unattainable area

Tech

nolo

gica

l Effi

cient

Short Run Marginal Product Curve

Increasin

g MP

Decreasing MP

Steepest Slope

Specialization and Division

Same Capital Same Space more worker

MP of additional

worker exceed MP of last

worker

Law Of Diminishing

Returns

Law of Diminishing: Marginal Production of one added unit of variable factor will diminish

Short Run Average Production Curve

Maximum point

Maximum point

Short Run Costs

=Cost of plant+ normal profit +sunk cost

Marginal total cost Change direction=inflection point

Economic of Scope Law of diminishing return

decrease rate

Increasing rate

Low Output

MC

Short Run Average Cost

Law

of d

imin

ishin

g re

turn ATC is U Shape:

•AFC diminishing•Return diminishing

Technology and Cost

Shift in cost curve

• Technology:

Output

Cost

AFC2AFC1

AVC1

AVC2

Less LaborMore Plant

ATC1ATC2

• Price of factor Production: Rent є Fixed Cost exp: interest rate of a truckWage є Variable Cost exp: Driver fare

If rent changes: FC, TFC, VFC, AFC would changeIf wage change: VC, TVC, AVC, MC would change

A short brief

Long Run Costscallop-shapedplanning Curve

Minimum efficient

Scale

∆output%>∆Production factor%

∆output%=∆Production factor%∆output%<∆Production factor%

Economically efficient plant size in short run

Difficulties of management

greater capitalization of labor and capital