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CHAPTER 11 Output and Costs

CHAPTER 11 Output and Costs. Learning Objectives. Explain what limits the profit a firm can make Explain the relationship between a firm’s output and costs in the short run when its capital is fixed Derive a firm’s short-run cost curves. Learning Objectives (cont.).

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CHAPTER 11 Output and Costs

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  1. CHAPTER11Output and Costs

  2. Learning Objectives • Explain what limits the profit a firm can make • Explain the relationship between a firm’s output and costs in the short run when its capital is fixed • Derive a firm’s short-run cost curves

  3. Learning Objectives (cont.) • Explain the relationship between a firm’s output and costs in the long run when its capital changes • Derive a firm’s long-run average cost curve

  4. Learning Objectives • Explain what limits the profit a firm can make • Explain the relationship between a firm’s output and costs in the short run when its capital is fixed • Derive a firm’s short-run cost curves

  5. Swanky • Throughout the chapter we are going to refer to Swanky, Inc., a producer of knitted sweaters.

  6. The Firm’s Objectiveand Constraints • The Objective: Profit Maximization • Firms attempts to maximize profit by using its scarce resources efficiently. • Two constraints limiting profit • Market constraints • Technology constraints

  7. The Firm’s Objectiveand Constraints • Market constraints • The conditions under which it can buy its inputs and sell its output • Technology constraints • The limits to the quantity of output that can be produced by using given quantities of inputs — productive resources

  8. The Firm’s Objectiveand Constraints • The Short Run and the Long Run • The short run is a period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied. • variable inputs and fixed inputs • The long run is a period of time in which the quantities of all inputs can be varied.

  9. Short-Run Technology Constraint • Increasing output in the short-run • firms must increase the quantity of labor • 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.

  10. Learning Objectives • Explain what limits the profit a firm can make • Explain the relationship between a firm’s output and costs in the short run when its capital is fixed • Derive a firm’s short-run cost curves

  11. 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

  12. 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

  13. 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

  14. Total Product Curve 15 Output (sweaters per day) 10 5 0 1 2 3 4 5 Labor (workers per day)

  15. Total Product Curve 15 f e d Output (sweaters per day) 10 c 5 b a 0 1 2 3 4 5 Labor (workers per day)

  16. Total Product Curve TP 15 f e d Output (sweaters per day) 10 c 5 b a 0 1 2 3 4 5 Labor (workers per day)

  17. Total Product Curve TP 15 f e Unattainable d Output (sweaters per day) 10 c Attainable 5 b a 0 1 2 3 4 5 Labor (workers per day)

  18. 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.

  19. 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

  20. Marginal Product TP 15 6 d Output (sweaters per day) 13 Marginal product (sweaters per day per worker) 4 10 c 3 5 2 4 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers per day) Labor (workers per day)

  21. Marginal Product TP 15 6 d Output (sweaters per day) 13 Marginal product (sweaters per day per worker) 4 10 c 3 5 2 4 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers per day) Labor (workers per day)

  22. Marginal Product TP 15 6 d Output (sweaters per day) 13 Marginal product (sweaters per day per worker) 4 10 c 3 5 2 4 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers per day) Labor (workers per day)

  23. Marginal Product The red highlights the point of diminishing returns TP 15 6 d Output (sweaters per day) 13 Marginal product (sweaters per day per worker) 4 10 c 3 5 2 4 0 1 23 4 5 0 1 23 4 5 Labor (workers per day) Labor (workers per day)

  24. Marginal Product The red highlights the point of diminishing returns TP 15 6 d Output (sweaters per day) 13 Marginal product (sweaters per day per worker) 4 10 c 3 5 2 4 0 1 2 3 4 5 0 1 2 3 4 5 Labor (workers per day) Labor (workers per day)

  25. Marginal Product The red highlights the point of diminishing returns TP 15 6 d Output (sweaters per day) 13 Marginal product (sweaters per day per worker) 4 10 c 3 5 2 4 0 1 23 4 5 0 1 23 4 5 Labor (workers per day) Labor (workers per day)

  26. Marginal Product The red highlights the point of diminishing returns TP 15 6 d Output (sweaters per day) 13 Marginal product (sweaters per day per worker) 4 10 c 3 5 2 4 MP 0 1 23 4 5 0 1 23 4 5 Labor (workers per day) Labor (workers per day)

  27. Average Product Curve What does the average product curve look like?

  28. Average Product 6 Average product & Marginal product (sweaters per day per worker) 4.33 4 3 2 0 1 2 3 4 5 Labor (workers per day)

  29. Average Product 6 c Average product & Marginal product (sweaters per day per worker) d 4.33 e 4 b f 3 2 0 1 2 3 4 5 Labor (workers per day)

  30. Average Product 6 c Average product & Marginal product (sweaters per day per worker) d 4.33 e 4 b f 3 AP 2 0 1 2 3 4 5 Labor (workers per day)

  31. Average Product Maximum average product 6 c Average product & Marginal product (sweaters per day per worker) d 4.33 e 4 b f 3 AP 2 MP 0 1 2 3 4 5 Labor (workers per day)

  32. Learning Objectives • Explain what limits the profit a firm can make • Explain the relationship between a firm’s output and costs in the short run when its capital is fixed • Derive a firm’s short-run cost curves

  33. 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.

  34. Short-Run Cost • Total cost (TC) is the cost of all productive resources used by a firm. • TC = TFC + TVC

  35. Total Cost Curves Total Total fixed variable Total cost cost cost Labor Output (TFC) (TVC) (TC) (workers (sweaters per day) per day) (dollars per day) a 0 0 b 1 4 c 2 10 d 3 13 e 4 15 f 5 16

  36. Total Cost Curves Total Total fixed variable Total cost cost cost Labor Output (TFC) (TVC) (TC) (workers (sweaters per 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

  37. Total Cost Curves Total Total fixed variable Total cost cost cost Labor Output (TFC) (TVC) (TC) (workers (sweaters per 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

  38. Total Cost Curves Total Total fixed variable Total cost cost cost Labor Output (TFC) (TVC) (TC) (workers (sweaters per 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

  39. Total Cost Curves 150 Cost (dollars per day) 100 50 0 5 10 15 Output (sweaters per day)

  40. Total Cost Curves 150 Cost (dollars per day) 100 50 TFC 0 5 10 15 Output (sweaters per day)

  41. Total Cost Curves 150 TVC Cost (dollars per day) 100 50 TFC 0 5 10 15 Output (sweaters per day)

  42. Total Cost Curves TC 150 TVC Cost (dollars per day) 100 50 TFC 0 5 10 15 Output (sweaters per day)

  43. 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.

  44. 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.

  45. Average Cost TC = TFC + TVC TC TFC TVC Q Q Q OR ATC = AFC + AVC = +

  46. 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

  47. 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 6.25 4.17 8.33 12.50 25.00

  48. 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 6.25 c 2 10 25 50 75 2.50 d 3 13 25 75 100 1.92 e 4 15 25 100 125 1.67 f 5 16 25 125 150 1.56 6.25 4.17 8.33 12.50 25.00

  49. 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 6.25 6.25 c 2 10 25 50 75 2.50 5.00 d 3 13 25 75 100 1.92 5.77 e 4 15 25 100 125 1.67 6.67 f 5 16 25 125 150 1.56 7.81 6.25 4.17 8.33 12.50 25.00

  50. 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 6.25 6.25 12.50 c 2 10 25 50 75 2.50 5.00 7.50 d 3 13 25 75 100 1.92 5.77 7.69 e 4 15 25 100 125 1.67 6.67 8.33 f 5 16 25 125 150 1.56 7.81 9.38 6.25 4.17 8.33 12.50 25.00

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