Economics 111.3 Winter 14

1. Economics 111.3 Winter 14 March 10th, 2014 Lecture 21 Ch. 11: Output and costs

2. Test 3 • Friday, March 14th, 2014 • 8:30 – 9:20 Room 200 STM • Chapters to be tested: 9, 10 (up to p. 231) and 11 (short-run costs only) • Format: Multiple-Choice Questions (MCQ): 30 questions – 100% of Test mark Time – 50 minutes

3. Short-Run Production Relationship: a recap Average product (the same as labour productivity) is calculated by dividing total output by the number of workers who produced it.

4. The Law of Diminishing Marginal Productivity (Diminishing Returns) The law of diminishing marginal productivity states that as more and more of a variable input is added to an existing fixed input, after some point the additional output obtained from the additional input will fall. This law is also called the flowerpot law, because it if did not hold true, the world’s entire food supply could be grown in a single flower pot.

5. total product AP= total labour input 15.00 14.00 12.50 10.71 8.75 10 10.00 15 12.50 20 15.00 15 10 5 0 -5

7. Marginal & Average Values • If the average value is rising, the marginal value must be ABOVE the average value • If the average value is falling, the marginal value must be BELOW the average value

8. Profit = Total revenue – Economic cost Costs of production in the short run are: Fixed Costs, Variable Costs, and Total Costs.

9. Fixed Costs • Fixed costs are those that are spent and cannot be changed in the period of time under consideration. • Fixed costs do not vary with changes in output (e.g., firm’s debt, rental payments, interest, insurance premiums) • In the long run there are no fixed costs since all costs are variable. • Sunk costs – a subset of fixed costs that are not recoverable if a firm goes out of business. Examples: advertising expenditures, purchasing the advice of a management consultant, market research

11. Variable Costs • Variable costs are costs that change as output changes, such as the costs of labour and materials. • NB! The increases in variable costs associated with succeeding one-unit increase in output are not equal

13. Total Costs • The sum of the variable and fixed costs are total costs: TC = FC + VC

16. 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.

17. Average Cost How are the average cost curves related to each other? OR

19. 340 25 400 20 470 550 16.67 640 14.29 750 12.50 880 11.11 10 1030 AFC=TFC / Q 100 190 100 270 50 33.33

20. 340 25 400 75 20 470 74 550 75 16.67 640 14.29 77.14 750 12.50 81.25 880 11.11 86.67 10 93 1030 AVC=TVC / Q 100 190 100 90 270 50 85 80 33.33

21. 340 25 400 75 100 94 20 470 74 550 75 91.67 16.67 640 91.43 14.29 77.14 750 93.75 12.50 81.25 880 97.78 11.11 86.67 10 93 1030 103 ATC=TC / Q 100 190 100 190 90 270 50 135 85 80 33.33 113.33

22. Marginal cost (MC) 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 cost decreases at low outputs because of the gains from specialization, but eventually increases due to the law of diminishing returns.

24. 340 60 25 400 75 100 70 94 20 470 74 80 550 75 91.67 16.67 90 640 91.43 14.29 77.14 110 750 93.75 12.50 81.25 130 880 97.78 11.11 86.67 150 10 93 1030 103 MC=TC / Q 100 90 190 100 190 90 80 270 50 135 85 70 80 33.33 113.33

25. Average fixed cost declines continuously as output increases  Average-Variable-Cost and Average-Total-Cost curves are U-shaped, reflecting increasing and then diminishing returns The Marginal-Cost curve falls when marginal returns increase, and rises when marginal returns diminish. The Marginal-Cost curve intersects both the Average-Variable- and Average-Total Cost curves at their minimum points.

26. Marginal Cost and Average Costs MC ATC AVC AFC 15 ATC = AFC + AVC 10 Cost (dollars per sweater) 5 0 5 10 15 Output (sweaters per day)

30. b) “At the current output level, this factory is subject to diminishing returns. Therefore, the firm is operating along the upward-sloping portion of its short-run average total cost curve”.

31. b) “At the current output level, this factory is subject to diminishing returns. Therefore, the firm is operating along the upward-sloping portion of its short-run average total cost curve”.