output and costs
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Output and CostsOutput and Costs
Michael ParkinECONOMICS 5e
TM 11-2Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between the short-run and the long-run
• Explain the relationship between a firm’s output and labor employed in the short-run
• Explain the relationship between a firm’s output and costs in the short-run
• Derive and explain a firm’s short-run cost curves
TM 11-3Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain the relationship between a firm’s output and costs in the long-run
• Derive and explain a firm’s long-run average cost curve
TM 11-4Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives• Distinguish between the short-run and the long-
run
• Explain the relationship between a firm’s output and labor employed in the short-run
• Explain the relationship between a firm’s output and costs in the short-run
• Derive and explain a firm’s short-run cost curves
TM 11-5Copyright © 1998 Addison Wesley Longman, Inc.
Sidney’s Sweaters Inc.
Throughout the chapter we are going to refer to Sidney’s Sweaters Inc., a producer of knitted sweaters. The firm is owned and operated by Sidney.
TM 11-6Copyright © 1998 Addison Wesley Longman, Inc.
Decision Time Frames
The Objective: Profit Maximization• All of the firm’s decisions are aimed at one overriding
objective: maximum attainable profit.
To study the relationship between a firm’s output decision and its costs, we distinguish two decision time frames:
• The short-run
• The long-run
TM 11-7Copyright © 1998 Addison Wesley Longman, Inc.
Decision Time Frames
The Short-Run and the Long-Run
The short-run is a time frame in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied.
The long-run is a time frame in which the quantities of all inputs can be varied.
A sunk cost is irrelevant to the firm’s decisions.
TM 11-8Copyright © 1998 Addison Wesley Longman, Inc.
Decision Time Frames
To increase output in the short-run, a firm must increase the quantity of labor employed.
Total product is the total output produced.
Marginal product is the increase in total product that result from a one-unit increase in an input.
Average product is the total product divided by the quantity of inputs.
TM 11-9Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between the short-run and the long-run
• Explain the relationship between a firm’s output and labor employed in the short-run
• Explain the relationship between a firm’s output and costs in the short-run
• Derive and explain a firm’s short-run cost curves
TM 11-10Copyright © 1998 Addison Wesley Longman, Inc.
Total Product, Marginal Product, and Average Product
Total Marginal Average Labor product product product (workers (sweaters (sweaters per (sweaters per day) per day) additional worker) per worker)
a 0 0
b 1 4
c 2 10
d 3 13
e 4 15
f 5 16
TM 11-11Copyright © 1998 Addison Wesley Longman, Inc.
Total Product, Marginal Product, and Average Product
Total Marginal Average Labor product product product (workers (sweaters (sweaters per (sweaters per day) per day) additional worker) per worker)
a 0 0
b 1 4
c 2 10
d 3 13
e 4 15
f 5 16
4
6
3
2
1
TM 11-12Copyright © 1998 Addison Wesley Longman, Inc.
Total Product, Marginal Product, and Average Product
Total Marginal Average Labor product product product (workers (sweaters (sweaters per (sweaters per day) per day) additional worker) per worker)
a 0 0
b 1 4 4.00
c 2 10 5.00
d 3 13 4.33
e 4 15 3.75
f 5 16 3.20
4
6
3
2
1
TM 11-13Copyright © 1998 Addison Wesley Longman, Inc.
Attainable
Total Product Curve
0 1 2 3 4 5Labor (workers per day)
5
10
15TP
Unattainable
Out
put (
swea
ters
per
day
)
a
b
c
d
e f
TM 11-14Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Product Curve
Marginal product is also measured by the slope of the total product curve.
Increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal product of the previous worker.
TM 11-15Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Product Curve
Diminishing marginal returns
Occur when the marginal product of an additional worker is less than the marginal product of the previous worker
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
TM 11-16Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Product
0 1 2 3 4 5Labor (workers per day)
5
10
15 TP
Out
put (
swea
ters
per
day
)
0 1 2 3 4 5Labor (workers per day)
2
4
6
Mar
gina
l pro
duct
(sw
eate
rs p
er d
ay p
er w
orke
r)4
3
13
MP
c
d
TM 11-17Copyright © 1998 Addison Wesley Longman, Inc.
Average Product Curve
What does the average product curve look like?
TM 11-18Copyright © 1998 Addison Wesley Longman, Inc.
Average Product
0 1 2 3 4 5Labor (workers per day)
2
4
6
Ave
rage
pro
duct
& M
argi
nal p
rodu
ct(s
wea
ters
per
day
per
wor
ker)
3
4.33
AP
MP
ef
b
d
cc
Maximumaverageproduct
TM 11-19Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives• Distinguish between the short-run and the long-
run
• Explain the relationship between a firm’s output and labor employed in the short-run
• Explain the relationship between a firm’s output and costs in the short-run
• Derive and explain a firm’s short-run cost curves
TM 11-20Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Cost
Total cost (TC) is the cost of all productive resources used by a firm.
Total fixed cost (TFC) is the cost of all the firm’s fixed inputs.
Total variable cost (TVC) is the cost of all the firm’s variable inputs.
TM 11-21Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Cost
Total cost (TC) is the cost of all productive resources used by a firm.
TC = TFC + TVC
TM 11-22Copyright © 1998 Addison Wesley Longman, Inc.
Total Cost CurvesTotal Totalfixed variable Totalcost cost cost
Labor Output (TFC) (TVC) (TC)(workers (sweatersper day) per day) (dollars per day)
a 0 0
b 1 4
c 2 10
d 3 13
e 4 15
f 5 16
TM 11-23Copyright © 1998 Addison Wesley Longman, Inc.
Total Cost Curves Total Total fixed variable Total cost cost cost
Labor Output (TFC) (TVC) (TC)(workers (sweatersper day) per day) (dollars per day)
a 0 0 25
b 1 4 25
c 2 10 25
d 3 13 25
e 4 15 25
f 5 16 25
TM 11-24Copyright © 1998 Addison Wesley Longman, Inc.
Total Cost Curves Total Total fixed variable Total cost cost cost
Labor Output (TFC) (TVC) (TC)(workers (sweatersper day) per day) (dollars per day)
a 0 0 25 0
b 1 4 25 25
c 2 10 25 50
d 3 13 25 75
e 4 15 25 100
f 5 16 25 125
TM 11-25Copyright © 1998 Addison Wesley Longman, Inc.
Total Cost Curves Total Total fixed variable Total cost cost cost
Labor Output (TFC) (TVC) (TC)(workers (sweatersper day) per day) (dollars per day)
a 0 0 25 0 25
b 1 4 25 25 50
c 2 10 25 50 75
d 3 13 25 75 100
e 4 15 25 100 125
f 5 16 25 125 150
TM 11-26Copyright © 1998 Addison Wesley Longman, Inc.
TC
TVC
Total Cost Curves
0 5 10 15Output (sweaters per day)
50
100
150
Cos
t (do
llars
per
day
)
TFC
TC = TFC + TVC
TM 11-27Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Cost
Marginal cost is the increase in total cost that results from a one-unit increase in output.
It equals the increase in total cost divided by the increase in output.
Marginal costs decrease at low outputs because of the gains from specialization, but it eventually increases due to the law of diminishing returns.
TM 11-28Copyright © 1998 Addison Wesley Longman, Inc.
Average Cost
Average fixed cost (AFC) is total fixed cost per unit of output.
Average variable cost (AVC) is total variable cost per unit of output.
Average total cost (ATC) is total cost per unit of output.
TM 11-29Copyright © 1998 Addison Wesley Longman, Inc.
Average Cost
TC = TFC + TVC
TC TFC TVC
Q Q Q= +
OR
ATC = AFC + AVC
TM 11-30Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Cost and Average Costs Total Total Average Average fixed fixed Total Marginal fixed variable Total cost cost cost cost cost cost cost
Labor Output (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC) (workers (sweaters (dollars per per day) per day) (dollars per day) additional sweater) (dollars per sweater)
a 0 0 25 0 25
b 1 4 25 25 50
c 2 10 25 50 75
d 3 13 25 75 100
e 4 15 25 100 125
f 5 16 25 125 150
TM 11-31Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Cost and Average Costs Total Total Average Average fixed fixed Total Marginal fixed variable Total cost cost cost cost cost cost cost
Labor Output (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC) (workers (sweaters (dollars per per day) per day) (dollars per day) additional sweater) (dollars per sweater)
a
b
c
d
e
f
0
1
2
3
4
5
0
4
10
13
15
16
25
25
25
25
25
25
0
25
50
75
100
125
25
50
75
100
125
150
6.25
4.17
8.33
12.50
25.00
TM 11-32Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Cost and Average Costs Total Total Average Average fixed fixed Total Marginal fixed variable Total cost cost cost cost cost cost cost
Labor Output (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC) (workers (sweaters (dollars per
per day) per day) (dollars per day) additional sweater) (dollars per sweater)
a
b
c
d
e
f
0
1
2
3
4
5
0
4
10
13
15
16
25
25
25
25
25
25
0
25
50
75
100
125
25
50
75
100
125
150
6.25
4.17
8.33
12.50
25.00
—
6.25
2.50
1.92
1.67
1.56
TM 11-33Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Cost and Average Costs Total Total Average Average fixed fixed Total Marginal fixed variable Total cost cost cost cost cost cost cost
Labor Output (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC) (workers (sweaters (dollars per
per day) per day) (dollars per day) additional sweater) (dollars per sweater)
a
b
c
d
e
f
0
1
2
3
4
5
0
4
10
13
15
16
25
25
25
25
25
25
0
25
50
75
100
125
25
50
75
100
125
150
6.25
4.17
8.33
12.50
25.00
—
6.25
2.50
1.92
1.67
1.56
—
6.25
5.00
5.77
6.77
7.81
TM 11-34Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Cost and Average Costs Total Total Average Average fixed fixed Total Marginal fixed variable Total cost cost cost cost cost cost cost
Labor Output (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC) (workers (sweaters (dollars per per day) per day) (dollars per day) additional sweater) (dollars per sweater)
a
b
c
d
e
f
0
1
2
3
4
5
0
4
10
13
15
16
25
25
25
25
25
25
0
25
50
75
100
125
25
50
75
100
125
150
6.25
4.17
8.33
12.50
25.00
—
6.25
2.50
1.92
1.67
1.56
—
6.25
5.00
5.77
6.77
7.81
—
12.50
7.50
7.69
8.33
9.38
TM 11-35Copyright © 1998 Addison Wesley Longman, Inc.
MC
ATC
AVC
AFC
Marginal Cost and Average Costs
0 5 10 15Output (sweaters per day)
5
10
15C
ost (
dolla
rs p
er s
wea
ter)
ATC = AFC + AVC
TM 11-36Copyright © 1998 Addison Wesley Longman, Inc.
Cost Curves and Product Curve
How are the product curves related to the cost curves?
TM 11-37Copyright © 1998 Addison Wesley Longman, Inc.
AP
MP
Product Curvesand Cost Curves
Labor
Ave
rage
pro
duct
and
mar
gina
l pro
duct
0 1.5 2.0
22
4
6
Rising MP andfalling MC:rising AP andfalling AVC
Falling MP andrising MC:rising AP andfalling AVC
Falling MP andrising MC:falling AP andrising AVC
TM 11-38Copyright © 1998 Addison Wesley Longman, Inc.
AVC
MC
Product Curvesand Cost Curves
Labor
Ave
rage
pro
duct
and
mar
gina
l pro
duct
0 6.5 10
3
6
9
12
Maximum AP and minimum AVC
Maximum MP and minimum MC
TM 11-39Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain the relationship between a firm’s output and costs in the long run
• Derive and explain a firm’s long-run average cost curve
TM 11-40Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Cost
Long-run cost
• The cost of production when a firm uses the economically efficient quantities of labor and capital.
Long-run costs are affected by the production function.
Production function
• The relationship between the maximum output attainable and the quantities of both labor an capital.
TM 11-41Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain the relationship between a firm’s output and costs in the long run
• Derive and explain a firm’s long-run average cost curve
TM 11-42Copyright © 1998 Addison Wesley Longman, Inc.
The Production Function
1 4 10 13 15
2 10 15 18 21
3 13 18 22 24
4 15 20 24 26
5 16 21 25 27
Knitting machines (number) 1 2 3 4
Output (sweaters per day)
Labor Plant 1 Plant 2 Plant 3 Plant 4
TM 11-43Copyright © 1998 Addison Wesley Longman, Inc.
The Long-Run Average Cost Curve
The long-run average total cost curve is derived from the short-run average total cost curves.
The segment of the short-run average total cost curves along which average total cost is the lowest make up the long-run average total cost curve.
TM 11-44Copyright © 1998 Addison Wesley Longman, Inc.
Short-Run Costs of Four Different Plants
TM 11-45Copyright © 1998 Addison Wesley Longman, Inc.
Long-Run Average Cost Curve
TM 11-46Copyright © 1998 Addison Wesley Longman, Inc.
Returns to Scale
Returns to scale are the increases in output that result from increasing all inputs by the same percentage.
Three possibilities:
• Constant returns to scale
• Increasing returns to scale
• Decreasing returns to scale
TM 11-47Copyright © 1998 Addison Wesley Longman, Inc.
Returns to Scale
Constant returns to scale
Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by the same percentage
TM 11-48Copyright © 1998 Addison Wesley Longman, Inc.
Returns to Scale
Increasing returns to scale
Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by a larger percentage
TM 11-49Copyright © 1998 Addison Wesley Longman, Inc.
Returns to Scale
Decreasing returns to scale
Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by a smaller percentage
TM 11-50Copyright © 1998 Addison Wesley Longman, Inc.
Minimum Efficient Scale
A firm’s minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level.
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