1. CH. 10: OUTPUT AND COSTS  Measures of a firm’s costs.  Distinction between the short run and the long run  The relationship between a firm’s output and labor employed in the short run  The relationship between a firm’s output and costs in the short run  A firm’s short-run cost curves  Relationship between a firm’s output and costs in the long run

2. Decision Time Frames The Short Run  A 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 Run  A time frame in which the quantities of all resources —including capital — can be varied.  No fixed inputs in the long run.

3. Decision Time Frames Sunk Costs.  A cost incurred by the firm that cannot be changed.  If a firm’s plant has no resale value, the amount paid for it is a sunk cost.  Sunk costs are irrelevant to a firm’s 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.

4. SR Measures of Production Total product (TP) Units of output produced in a given period. Marginal product of labor (MP L )  D TP resulting from one additional unit of L, ceteris paribus.  D TP/ D L Average product of labor (AP L ) TP/L

5. Relationship between TP, MP and AP The Total Product Curve

6. Relationship between TP, MP and AP The Total Product Curve

7. Relationship between TP, MP and AP Almost all production processes are like the one shown here and have: – Initially increasing marginal returns – Eventually diminishing marginal returns

8. Relationship between TP, MP and AP  Increasing marginal returns MP rises as use of input increases Results from increased specialization and division of labor.  Diminishing marginal returns MP falls as use of input increases Occurs 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.

9. Short-Run Technology Constraint IF MP>AP, what happens to AP if L is increased? If MP<AP, what happens to AP if L is increased? MP=AP when AP is at a maximum.

10. Suppose that a firm has 10 workers producing tables, AP L is 5 and MP L of the 11 th worker is 4. What is TP with 10 workers?

11. Suppose that a firm has 10 workers producing tables, AP L is 5 and MP L of the 11 th worker is 4. What is TP with 11 workers?

12. Suppose that a firm has 10 workers producing tables, AP L is 5 and MP L of the 11 th worker is 4. If the 11 th worker is added, we know that: 1.AP L will decrease. 2.AP L will increase. 3.MP L will increase.

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

14. SR Total Cost Curves

15. SR Costs Marginal Cost  the increase in total cost that results from a one- unit increase in total product.  D TC/ D TP  If labor is the only variable input, MC=W/ MP L  Over 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.

16. SR Costs Average Costs – Average fixed cost (AFC) = TFC/TP – Average variable cost (AVC) = TVC/TP If labor is the only variable input, AVC=W/AP L – Average total cost (ATC) is total cost per unit of output. ATC = TC/TP = AFC + AVC.

17. SR Costs Marginal vs. AVC and ATC  If MC<AVC, AVC decreases as TP increases  If MC>AVC, AVC increases as TP increases  If MC<ATC, ATC decreases as TP increases  If MC>ATC, ATC increases as TP increases

18. SR Cost Curves The ATC curve is U- shaped. If MC<AVC, AVC is falling. If MC>AVC, AVC is rising. MC always interesects ATC at min of ATC AVC at min of AVC AFC always decreases as output increases.

19. Relationship between production and cost

20. Short-Run Cost Shifts in Cost Curves – The position of a firm’s cost curves depend on two factors:  Technology  Prices of productive resources  What is effect on ATC, MC, AVC of Increase in price of labor. Increase in fixed costs Increase in productivity of labor.

21. Fill in the table below TPTCTFCTVCATCAVCMC 0100 1150 2190 3240 4300 5400

22. Long-Run Cost In the long run, all inputs are variable and all costs are variable. The Production Function – Shows the relationship between the maximum output attainable and the quantities of both capital and labor.

23. Long-Run Cost – Marginal product of capital (MP k ) the increase in TP from one more unit of capital, ceteris paribus. – A firm’s 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.

24. LR Cost What’s 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=1 K=2 K=3 K=4

25. LR Cost The long-run average cost (LRAC) curve.

26. LR Cost Economies 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.

27. Long-Run Cost

28. – Minimum efficient scale is the smallest quantity of output at which the long-run average cost reaches its lowest level. LRATC MES

29. Market Structure and Minimum Efficient Scale As MES rises relative to consumer demand, the number of firms in the industry will fall. Cases to consider:  Microsoft  Steel industry  Printing industry  Farming