output and costs

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


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


Learning Objectives• Distinguish between the short-run and the long-

run





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.


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



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.



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.


Learning Objectives

• Distinguish between the short-run and the long-run





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




a 0 0

b 1 4

c 2 10

d 3 13

e 4 15

f 5 16

4

6

3

2

1




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


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


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.


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


Marginal Product


5

10

15 TP

Out

put (

swea

ters

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


Average Product Curve

What does the average product curve look like?


Average Product


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


Learning Objectives• Distinguish between the short-run and the long-

run





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.


Short-Run Cost

Total cost (TC) is the cost of all productive resources used by a firm.

TC = TFC + TVC


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


Total Cost Curves Total Total fixed variable Total cost cost cost


a 0 0 25

b 1 4 25

c 2 10 25

d 3 13 25

e 4 15 25

f 5 16 25




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




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


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


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.


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.


Average Cost

TC = TFC + TVC

TC TFC TVC

Q Q Q= +

OR

ATC = AFC + AVC


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




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



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



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




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


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


Cost Curves and Product Curve

How are the product curves related to the cost curves?


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


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



• Explain the relationship between a firm’s output and costs in the long run



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.



• Explain the relationship between a firm’s output and costs in the long run



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


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.


Short-Run Costs of Four Different Plants


Long-Run Average Cost Curve


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


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


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


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


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.

output and costs

Documents

firms short

cost curvestotal product

attainabletotal product

longrunthe shortrun

total output

firms decisions

cost curvessidneys sweaters

producer of knitted