1. 5-2: What Are the Costs of Production?
Chapter 5: Supply

2. 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?

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

4. 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

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

6. 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

7. 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

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

9. 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

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

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

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

13. Total Cost
Definition: the sum of fixed and variable costs

14. 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

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

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

17. 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)

18. 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

19. 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

20. 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

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

22. 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

23. 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.

24. 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.