CH. 11: OUTPUT AND COSTS

1. CH. 11: OUTPUT AND COSTS • Measure of relationship between output and cost • Production function • Shows relationship between inputs and output • Law of diminishing marginal returns • Cost function • Shows relationship between output and cost • Short run vs long run cost • Economies of Scale and Scope

2. Short run vs. Long run • 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 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 escaped after it is incurred • If a firm’s plant has no resale value, the amount paid for it is a sunk cost. • If a firm pays for research and development, the cost is sunk after incurred – regardless of whether the R&D had a successful outcome • Sunk costs are irrelevant to a firm’s decisions since the firm cannot escape sunk costs after they have been incurred.

4. SR Measures of Production • Total product (TP) • Units of output produced in a given period. • Marginal product of labor (MPL) • D TP resulting from one additional unit of L, ceteris paribus. • DTP/DL • Average product of labor (APL) • 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 • 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 eventuallydiminishes.

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. 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

11. SR Total Cost Curves

12. SR Costs • Marginal Cost • the increase in total cost that results from a one-unit increase in total product. • DTC/DTP • If labor is the only variable input, MC=W/ MPL • 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.

13. 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/APL • Average total cost(ATC) is total cost per unit of output. ATC = TC/TP = AFC + AVC.

14. 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 .

15. Relationship between production and cost

16. 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.

17. Fill in the table below

18. Fill in the table below

19. 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.

20. Long-Run Cost • Marginal product of capital (MPk) • 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.

21. LR Cost 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=2 K=1 K=3 K=4 What’s the low cost method for producing 5 sweaters? 13 sweaters? 25 sweaters?

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

23. 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.

24. Long-Run Cost

25. Long-Run Cost • Minimum efficient scale is the smallest quantity of output at which the long-run average cost reaches its lowest level. LRATC MES

26. 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