Jeremy's Bakery and Level of Production

Jeremy has a bakery that specializes in custom cakes. When he works alone, he can make 4
cakes in an hour. Overall, Jeremy has to do everything if he works alone including

Moving ingredients Mixing ingredients Pouring ingredients into pan

Placing them in the oven Monitoring the baking Applying the icing
Customizing the messages Packaging Delivery

Jeremy is pretty quick at some parts of the

job, but is slow at others. By bringing in
another worker, they can now produce a
total a 10 cakes. The second worker allows
Jeremy to focus on a few parts of the
production process and the second worker
focuses on the other half of the tasks. They
are experiencing synergy and economies of
scale.

If a third worker is introduced, this will again

allow workers to further reduce the number
of tasks each does, and subsequently, the
amount of time wasted when shifting from
Task A to Task B. This third worker takes the
total production from 10 to 17 cakes,
meaning the marginal production is 7 units.
The average production per worker goes up
from 5 to 5.7 cakes per hour.

The 4th worker adds 6 more cakes. Although it is less output than the previous worker, this worker still
makes the average production per worker go up.

The 5th, 6th, and 7th workers all add to the total output, but their contributions continue to diminish
relative to previous workers. Although additional workers are added, there isn't enough space and
equipment to allow them to contribute at a rate as quick as the previous workers. There is also the
possibility that they are not as skilled as the ones who were hired first.

The final 2 workers diminish total output. Their presence might actually inhibit others from being as
efficient because they are in the way or are a distraction. With 10 workers around, it might be harder
for Jeremy to effective manage, monitor and motivate everyone which could also contribute to the
diminishing levels of total output.
The marginal product is the additional output the will be put out by an

additional worker, while other inputs (capital) remain fixed.

The average product (AP) is calculated by

dividing total output by the

number of workers that produced that

output:

AP = TP/L

A production function describes the firm’s

technology and the relationship between
output and factors of production. It tells us
the maximum amount of output that can be
derived from a given number of inputs. For
a fixed amount of capital, the production of
output as we increase labor will look like:

Area A: average and marginal productivities are rising

Area B: marginal productivity is falling, average productivity still rising but eventually falling;

Area C: Both marginal and average productivities falling.

When firms make production decisions, the most relevant of the production

function is the part exhibiting diminishing marginal productivity (area B).

The law of diminishing marginal productivity states that if the amount of one input
(capital) is fixed, using more and more units of a variable input (labor) will result

in the marginal product of the variable input to start falling after some point. The

law of diminishing marginal productivity assumes that at least one input is held

fixed and cannot be increased.

Total Costs, Fixed costs, and Variable Costs

Total costs (TC) are the sum of Total Fixed Costs (TFC) plus Total Variable

Costs (TVC):

TC = TFC + TVC

Total fixed costs: the total costs incurred by the firm for variable inputs that are

held fixed in the short-run. If the period under consideration is the long-run, then

there are no fixed costs because all inputs in the long run are variable and

therefore, the cost associated with those inputs are also variable.

Total variable costs are the total costs incurred for variable inputs.

Average Total Costs, Average Fixed Costs,

and Average Variable Costs.

Average total cost (ATC) of the firm is the total cost divided by quantity.
ATC = TC / Q

Average fixed cost (AFC) of the firm is the total fixed cost divided by quantity.

AFC = TFC / Q

Average variable cost (AFC) of the firm is the total variable cost divided by

quantity.

AVC = TVC / Q

Average total costs can also be expressed as the sum of AFC and AVC

ATC = AFC + AVC

In deciding how many units to produce the most important variable is the

marginal cost – the increase (decrease) in total costs from increasing

(decreasing) output.

Graph

Economies of Scale

Number of Total Output Marginal Output Average Product

Workers (Change in Total) Per Worker
0 0
1 8 8 8.0
2 18 10 9.0
3 30 12 10.0
4 42 12 10.5
5 54 12 10.8
6 65 11 10.8
7 75 10 10.7
8 85 10 10.6
9 93 8 10.3
10 100 7 10.0
11 105 5 9.5
12 108 3 9.0
13 107 1 8.2
14 107 0 7.6
15 106 -1 7.1
16 102 -4 6.4
17 95 -7 5.6