5-2: What Are the Costs of Production? Chapter 5: Supply

How Labor Affects Production Sarah owns a small factory that produces custom blue jeans. Currently, there are 3 employees who can collectively produce 12 pairs of jeans per day. If Sarah hired one additional worker, how would that affect production?

Marginal Product To answer that, we look at marginal product: the change in total output by adding one more worker

Marginal Product (continued) We see that with 4 workers, Sarah’s factory can produce 19 pairs of jeans each day— that is a marginal product of 7 pairs of jeans With a 5th worker output is 29 pairs of jeans, with a marginal product of 10

Marginal Product Schedule This shows the relationship between labor and marginal product

Sample Marginal Product Schedule # of Workers Total Product Marginal Product 1 3 2 7 4 12 5 19 29 10 6 42 13 53 11 8 61 9 66 67 65 -2

What can we learn from the marginal product schedule? Specialization increases marginal product At some point, total output still increases but marginal product begins to decrease

Increasing Returns Definition: when hiring new workers causes the marginal product to increase

Diminishing Returns Definition: when hiring new workers causes marginal product to decrease Looking at the marginal product schedule it can be seen there is a point when hiring more workers is counterproductive

Production Costs The goal of business is to earn as much profit as possible There are several different kids of costs

Fixed Costs Definition: costs the business owner incurs no matter how much they produce Examples: mortgage, insurance, and utilities

Variable Costs Definition: costs that vary based on the level of production output Example: wages

Total Cost Definition: the sum of fixed and variable costs

Production Costs Schedule #of Workers Total Product Fixed Costs ($) Variable Cost ($) Total Cost ($) Marginal Cost ($) 40 -- 1 3 30 70 10 2 7 62 102 8 12 97 137 4 19 132 172 5 29 212 6 42 211 251 53 277 317 61 373 413 9 66 473 513 20 67 503 543 11 65 539 579

Calculating Marginal Cost MC=change in total cost / change in total product For example: based on TC for 4 workers and 3 workers: TC: 172-137 =35 TP: 19-12=7 MC: 35/7 =5

Earning the Highest Profit Marginal Revenue: money made from the sale of each additional unit of output MR= price of the good being sold

Earning the Highest Profit (continued) Total revenue: income a business receives from selling its products TR= P x Q (Where P=price of product and Q=quantity purchased at that price)

Production Costs and Revenues Schedule #of Workers Total Product Total Cost ($) Marginal Cost ($) Marginal Revenue ($) Total Revenue ($) Profit ($) 40 -- -40 1 3 70 10 20 60 -10 2 7 102 8 140 38 12 137 240 103 4 19 172 5 380 208 29 212 580 368 6 42 251 840 589 53 317 1,060 743 61 413 1,220 807 9 66 513 1,320 67 543 30 1,340 797 11 65 579 1,300 721

How to Calculate the Production Costs and Revenues Schedule TR= MR x Total Product Profit=TR—TC The point on the chart where MC=MR On our schedule this would be when 9 workers are producing 66 pairs of jeans

Profit-maximizing Output Definition: the level of production at which a business realizes the greatest amount of profits Simply put this is where MC=MR

Questions & Problems 1. How does a business use marginal analysis to decide how many workers to employ?

2. Categorize the following costs incurred by a bookstore owner as fixed or variable: Accountant Electricity Wages Insurance for workers Manager’s salary Purchase of books Rent Phone

3. Suppose that a video store has total costs of $3,600 per month 3. Suppose that a video store has total costs of $3,600 per month. If you charge $12 per DVD, how many DVDs need to be sold each month in order to break even? 4. Then, explain how you arrived at this answer.

5. The owner of a factory that produces soccer balls determines that his marginal product is at its peak when he has 100 employees. He determines that his marginal cost and marginal revenue are equal when he has 150 employees. What number of employees should he hire in order to maximize his profit? Then, explain the reason for your answer.