Output and Costs

CHAPTER
11
Output and Costs
The Firms Objectives

and Constraints
The firms main objective is to
maximize economic profits.
This means they are making the best
(most efficient) use of scarce
resources.
Firms that try to maximize economic
profits will have the best chance of
surviving in a competitive
environment.
The Firms Objective

and Constraints
The Short Run and the Long Run
The short run is a period of time in
which the quantity of capital is fixed and
the quantities of the other inputs
(mainly labor) can be varied.
The long run is a period of time in which
the quantities of all inputs can be
varied.
How Long Is the Long Run?

In some industries consulting or
photocopying services the short
run may last only a month or two.
In other industries, the short run can
be several years. Electric power
generating and railroads are two
industries that take years to build
new capital.
Short-Run
Technology Constraint
In order to increase output in the
short-run (holding the capital stock
constant), firms must increase the
quantity of labor.
Short-Run
Technology Constraint
The effect of a change in the quantity of
labor, holding the capital stock constant,
can be described using three related
concepts:
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.
Total Product
Total product (TP) is the total
quantity of output produced with a
given quantity of a fixed input.
The total product curve shows the
maximum quantity of output that can
be produced with a given amount of
capital as the amount of labor
employed is varied.
The Total Product Curve

The total product curve is similar to
the production possibilities frontier.
Both separate attainable output
levels from those that are
unattainable.
Only points on the total product
curve are technologically efficient.
Total Product Schedule

a
b
c
d
e
f
Labor
0
1
2
3
4
5
Output
0
4
10
13
15
16
Output (sweaters per day)
Total Product Curve

15
10
Labor (workers per day)
Total Product Curve

15
e
d
10
5
b
a
0
Total Product Curve

15
TP
d
10
5
b
a
0
Total Product Curve

15
Unattainable
TP
d
10
c
Attainable
5
b
a
0
Marginal Product
The marginal product of an input is
the increase in total product divided
by the increase in the quantity of the
input employed, when the quantity of
all other inputs is constant.
Marginal Product of Labor

The marginal product of labor (MP) is
the increase in total product divided
by the increase in the quantity of
labor employed, when the quantity of
capital is constant.
MP= TP/ L
Marginal Product of Labor

Schedule
Labor
a
b
c
d
e
f
0
1
2
3
4
5
Total Product Marginal product

of Labor
0
4
4
10
6
13
3
15
2
16
1
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.

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
15
13
10
5
4
TP
Marginal product
(sweaters per day per worker)

6
4
3
2
0
4 5
4 5
15
13
10
5
4
TP
Marginal product

6
4
3
2
0
4 5
4 5
15
13
10
c
5
4
TP
Marginal product

6
4
3
2
0
4 5
4 5
15
13
10
5
4
TP
Marginal product

The red highlights
the point of
diminishing returns
6
4
3
2
0
4 5
4 5
15
13
10
5
4
TP
Marginal product

The red highlights
the point of
diminishing returns
6
4
3
2
0
4 5
4 5
15
13
10
5
4
TP
Marginal product

The red highlights
the point of
diminishing returns
6
4
3
2
0
4 5
4 5
15
13
10
5
4
TP
Marginal product

The red highlights
the point of
diminishing returns
6
4
3
2
0
4 5
MP
1
4 5
Average Product
The average product of an input is
equal to total product divided by the
quantity of the input employed.
Average product tells us how
productive, on average, a factor of
production is.
Average Product of Labor

The average product of labor is total
product divided by the quantity of
labor employed, when the quantity of
capital is constant.
AP = TP/L
Average Product of Labor

Schedule
Labor
a
b
c
d
e
f
0
1
2
3
4
5
Total Product
Marginal Average
Product
Product
of Labor of Labor
0
4
4
4
10
6
5
13
3
4.33
15
2
3.75
16
1
3.20
Average Product Curve

What does the average product
curve look like?
Average product & Marginal product


6
4.33
4
0
1
2
3
4
5


6
c
d
4.33
4
4
5


6
c
4.33
4
AP
4
5


Maximum
average
product
6
c
d
4.33
4
AP
MP
0
4
5
The Relationship Between

Marginal and Average
When marginal product is above
average product, average is rising
marginal is pulling average up.
When marginal product is below
average product, average is falling
marginal is pulling average down.
Marginal product intersects average
where average is at its maximum.
Marginal and Average Grade

The marginal grade is the grade you
receive in this class.
Your average grade is your G.P.A.
(grade point average).
If the grade you get in this class is
higher than your G.P.A., it will pull
your G.P.A. up.
If, on the other hand, ...
The Shapes of the

Product Curves
Total, marginal, and average product
curves for different goods will still
have similar shapes because almost
every production process
incorporates two features:
Increasing marginal returns initially
Diminishing marginal returns eventually
Increasing Marginal Returns

Increasing marginal returns occur
additional worker exceeds the
worker.
Increasing marginal returns will
usually be the rule when the quantity
of labor employed is low.
Diminishing Marginal
Returns
Diminishing marginal returns occur
additional worker is less than the
worker.
All production processes eventually
reach a point of diminishing marginal
returns.
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 eventually diminishes.
Because marginal product eventually
diminishes, so does average
product.
Short-Run Cost
To produce more output in the short
run, a firm must employ more labor.
This will also increase its cost.
To produce more output, a firm must
increase its costs.
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 firms fixed inputs.
Total variable cost (TVC) is the cost
of all the firms variable inputs.
Total Cost
A firms total cost is the sum of the
costs of all the inputs it uses in
production.
Total cost includes the cost of
renting land, buildings and
equipment; wages paid to the work
force; and normal profit.
Total Fixed Cost and

Total Variable Cost
Total cost (TC) is divided into two
categories:
Total fixed cost (TFC)
Total variable cost (TVC)
TC = TFC + TVC
Total Fixed Cost

A fixed cost is the cost of a fixed
input.
Fixed cost doesnt change when
output changes.
Total fixed cost is the total cost of
the fixed inputs.
Total Variable Cost

A variable cost is a cost of a variable
input.
Variable costs change when the level
of output changes.
Total variable cost is the total cost of
the variable inputs.
Cost (dollars per day)
Total Cost Curves

150
100
50
TFC
0
10
15
Total Cost Curves

150
TVC
100
50
TFC
0
10
15
Total Cost Curves

TC
150
TVC
100
50
TFC
0
10
15
Marginal Cost
Marginal cost (MC) is the increase in
its total cost divided by the increase
in its output.
Marginal cost is the increase in total
cost that results from a one unit
increase in output.
MC = TC/ Q
Marginal Cost
Because fixed costs dont change as
output changes, marginal cost is
also the increase in total variable
cost divided by the increase in
output.
MC = TC/ Q
MC = TVC/ Q + TFC/ Q
MC = TVC/ Q +
0
Marginal Cost
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 cost is the cost per unit of
output.
There are three average costs:
Average fixed cost
Average variable cost
Average total cost
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 Measures

Average total cost (ATC) is total cost
per unit of output. It is the sum of
average fixed cost (AFC) and
average variable cost (AVC).
Average Cost
Total Cost = TC = TFC + TVC
Average Total Cost = ATC
TC TFC TVC
=
+
Q
Q
Q
ATC = AFC+AVC
OR
Marginal Cost and Average Costs

Total Total
Average Average Average
fixed variable Total Marginal fixed
variable Total
Labor Output cost cost
cost cost
cost
cost
cost
L
Q
(TFC) (TVC) (TC) (MC)
(AFC)
(AVC)
(ATC)
(workers (sweaters
per day)
per day) $/day $/day
$/day
$/day
$/day
25
25
25
25
50
6.25
6.25
6.25
12.50
10
25
50
75
4.17
2.50
5.00
7.50
13
25
75
100
8.33
1.92
5.77
7.69
15
25
100
125
12.50
1.67
6.67
8.33
16
25
125
25.00
$/day
150
$/day
1.56
7.81
9.38
Cost (dollars per sweater)
Marginal Cost and Average

Costs
15
10
AFC
10
15

Costs
15
10
AVC
AFC
10
15

Costs
15
ATC = AFC + AVC
ATC
AVC
10
AFC
10
15

Costs
15
ATC = AFC + AVC
MC
ATC
AVC
10
AFC
10
15

Costs
15
ATC = AFC + AVC
MC
ATC
AVC
10
Minimum points
AFC
10
15
Short-Run Cost Curves

Total fixed cost is constant.
Total variable cost and total cost both
increase with output.
Average fixed cost slopes downward.
The average total cost and average
variable cost curves are U-shaped.
The marginal cost curve is also U-shaped.
The MC curve intersects the ATC and AVC
at their respective minimums.
Why the Average Total Cost

Curve is U-Shaped
There are two opposing forces that
guarantee the short-run average total
cost curve will be U-shaped:
Decreasing average fixed cost
Eventually increasing average variable
cost caused by diminishing returns
The shape of the ATC curve

combines these two effects.
Shifts in the Cost Curves

The position of a firms short-run
cost curves depend on technology
and the prices it pays for inputs.
If technology changes or if factor
prices change, the firms costs
change and its cost curves shift.
Changes in Factor Prices

and Shifting Cost Curves
An increase in factor prices
increases costs and shifts the cost
curves upward.
Changes in fixed cost only affect the
fixed and total cost curves.
Changes in variable cost shifts the
variable, total, and marginal cost
curves.
Cost and Product Curves

Average and Marginal Product and Cost
The firms cost curves and product
curves are linked:
MC is at its minimum at the same output
level at which MP is at its maximum.
When MP is rising, MC is falling.
AVC is at its minimum at the same
output level at which AP is at its maximum.
When AP is rising, AVC is falling.
Cost and Product

Curves

Output and Costs

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Output and Costs

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CHAPTER

Output and Costs

The Firms Objectives

The Firms Objective

How Long Is the Long Run?

The Total Product Curve

Total Product Schedule

Output (sweaters per day)

Total Product Curve

Labor (workers per day)

Output (sweaters per day)

Total Product Curve

Labor (workers per day)

Output (sweaters per day)

Total Product Curve

Labor (workers per day)

Output (sweaters per day)

Total Product Curve

Labor (workers per day)

Marginal Product of Labor

Marginal Product of Labor

Total Product Marginal product

Marginal Product Curve

Marginal Product Curve

Law of diminishing returns

Output (sweaters per day)

Marginal Product Curve

Output (sweaters per day)

Marginal Product Curve

Output (sweaters per day)

Marginal Product Curve

Output (sweaters per day)

Marginal Product Curve

Output (sweaters per day)

Marginal Product Curve

Output (sweaters per day)

Marginal Product Curve

Output (sweaters per day)

Marginal Product Curve

Average Product of Labor

Average Product of Labor

Average Product Curve

Average product & Marginal product

Average Product Curve

Average product & Marginal product

Average Product Curve

Average product & Marginal product

Average Product Curve

Average product & Marginal product

Average Product Curve

The Relationship Between

Marginal and Average Grade

The Shapes of the

Increasing Marginal Returns

Total Fixed Cost and

Total Fixed Cost

Total Variable Cost

Cost (dollars per day)

Total Cost Curves

Output (sweaters per day)

Cost (dollars per day)

Total Cost Curves

Output (sweaters per day)