ECON101 Notes 1

ECON101: Introductory
Microeconomics
Topic 5
Technology, Production and
Costs
Essential reading:
Hubbard et al. (2017), Microeconomics, 4th edition,
Pearson Education Australia,
Chapter 7
ECON101: Introductory
Microeconomics
These powerpoint slides are a modified version
of the slides that form part of the teaching
resources provided by Pearson Australia with
the text book
Copyright ©2018 Pearson Australia (a division

of Pearson Australia Group Pty Ltd) –
9781488612497/Hubbard/Microeconomics/4th
edition
Chapter 7
Technology,
Production and Costs
Learning objectives
1. Define technology and give examples of technological change.
2. Distinguish between the economic short run and the economic

long run.
3. Understand the relationship between the marginal product of

labour and the average product of labour.
4. Explain and illustrate the relationship between marginal cost and

average total cost.
5. Graph average total cost, average variable cost, average fixed

cost and marginal cost.
6. Understand how firms use the long-run average cost curve in

their planning.
4 Copyright ©2018 Pearson Australia (a division of Pearson Australia Group Pty Ltd)–9781488612497/Hubbard/Microeconomics/4e
COSTS AND BUSINESS DECISIONS IN THE CAFÉ
INDUSTRY
In the example of a café, as
the number of tables,
chairs, cash registers and so
on remain fixed in the short
run (in economics we would
say that capital is ‘fixed’),
each successive employee
hired (or extra hour worked)
beyond a certain number
will result in a lower
increase in output than the
one before. © conrado | Shutterstock
TECHNOLOGY: AN ECONOMIC DEFINITION
 Technology: The processes a firm uses to turn inputs into outputs of

goods and services.
 Technological change: A change in the ability of a firm to produce

output with a given quantity of inputs.
Examples of technological change
• Technological change can come from

many sources, such as:
 Rearrangement of a factory floor
 Change in the layout of a retail store
 A training program for a firm’s
employees
 Adoption of a more efficient harvester
in crop production
7
THE SHORT RUN AND THE LONG RUN IN ECONOMICS
 Short run: The period of time during which at least one of the firm’s
inputs is fixed.
 Long run: A period of time long enough to allow a firm to vary all of
its inputs, to adopt new technology, and to increase or decrease the
size of its physical plant.
• The definition of the short and long run

will vary from one industry to another,
depending on the production cycle and
the nature of the technologies and
capital items used in production
9
(cont’d)
The difference between fixed costs and variable costs
 Total cost: The cost of all the inputs a firm uses in production.
 Variable costs: Costs which change as the quantity of output
changes.
 Fixed costs: Costs which remain constant as the quantity of output
changes.
All of a firm’s costs are either fixed or variable, so we can state:
Total Cost = Fixed Cost + Variable Cost

(or using symbols…TC = FC + VC)
Improving inventory control at Bunnings
Making the Connection 7.1
 Inventories are an input into Bunnings’ output sold to consumers.

Holding inventories is costly, so firms have an incentive to hold as
few inventories as possible and turn over their inventories as
rapidly as possible.
 In recent years, many firms have adopted ‘just-in-time’ inventory
systems in which firms accept shipments from suppliers as close
as possible to the time they will be needed.
 Bunnings actively manages its supply chain stretching from the
manufacturers of the goods it sells to its retail stores.
(cont’d)
Implicit costs versus explicit costs
 Opportunity cost: The highest-valued alternative that must be

given up to engage in an activity.
 Explicit cost: A cost that involves spending money.
 Implicit cost: A non-monetary opportunity cost.
Julie Johnson’s costs per year: Table 7.1
Costs Per Year, $

Paper 20 000
Wages 48 000
Explicit Lease payment for photocoping 10 000
costs machines
Electricity 6 000
Lease payment for store 24 000
Forgone salary 40 000
Implicit
Forgone interest 3 000
costs
Economic depreciation 10 000
Total 161 000
Fixed costs in the publishing industry
Academic publishers hire editors,

designers, and production and
marketing managers who help
prepare books for publication.
Because these employees work on
several books simultaneously, the
number of people the company hires
will not go up and down with the
quantity of books the company
publishes during any particular year.
Therefore, their salaries are
considered a fixed cost by
publishers.
Fixed costs in the publishing industry (cont’d)
(cont’d)
 Production function: The relationship between the inputs
employed by the firm and the maximum output it can produce with
those inputs
A first look at the relationship between production and cost
 Average total cost: Total cost divided by the quantity of output

produced.
Short-run production and cost at Julie Johnson’s
photocopying store: Table 7.2
Graphing total cost and average total cost at Julie
Johnson’s photocopying store: Figure 7.1
We can use the information from Table 7.2 to graph the relationship between the quantity of photocopies Julie produces and her total cost and
average total cost. Panel (a) shows that total cost increases as the level of production increases. In panel (b) we see that the ATC curve is
roughly U-shaped: as production increases from low levels, the ATC curve falls before rising at higher levels of production. To understand why
the ATC curve has this shape we must look more closely at the technology of producing photocopies, as shown by the production function.
THE MARGINAL PRODUCT OF LABOUR AND THE
AVERAGE PRODUCT OF LABOUR
 Marginal product of labour: The additional output a firm
produces as a result of hiring one more worker.
 Law of diminishing returns: The principle that, at some point,

adding more of a variable input, such as labour, to the same
amount of a fixed input, such as capital, will cause the marginal
product of the variable input to decline.
The marginal product of labour at Julie Johnson’s
photocopying store: Table 7.3
THE MARGINAL PRODUCT OF LABOUR AND THE
AVERAGE PRODUCT OF LABOUR (cont’d)
The relationship between marginal product
and average product
Average product of labour: The total output produced by a firm

divided by the quantity of workers.
733.3 = (625 + 700 + 875) / 3
Average Marginal Marginal Marginal

product of product of product of product of
labour for labour for labour for labour for
three the first the second the third
workers worker worker worker
Total output, the marginal product of labour and
the average product of labour: Figure 7.2
THE RELATIONSHIP BETWEEN SHORT-
RUNPRODUCTION AND SHORT-RUN COST
Marginal cost: The change in a firm’s total cost from producing
one more unit of a good or service.
MC = D TC
DQ
Julie Johnson’s marginal cost and average total cost of
producing copies: Figure 7.3
24
Solved Problem 1
The relationship between marginal cost
and average total cost
Is Julie Johnson right or wrong when she says the following?

‘I am currently producing 10 000 copies per day at a total cost of
$500.00. If I produce 10 001 copies my total cost will rise to
$500.11.Therefore, my average total cost of producing copies must
be increasing.’
Draw a graph to illustrate your answer.
Solved Problem 1
Solving the problem:
STEP 1: Review the chapter material. The problem requires

understanding the relationship between marginal cost and
average total cost, so you may like to review the section in
the textbook, ‘The relationship between marginal cost and
average total cost’.
STEP 2: Calculate average total cost and marginal cost. Average

total cost is total cost divided by total output. In this case
average total cost is: $500.11/10001 = $0.05. Marginal cost
is the change in total cost divided by the change in output. In
this case marginal cost is: $0.11/1 = $0.11.
Solved Problem 1
STEP 3: Use the relationship between marginal cost and

average total cost to answer the question.
When marginal cost is greater than average total cost,
marginal cost must be increasing. Since, in Step 2 we found
that MC>ATC, therefore ,Julie is right: her average cost of
producing copies must be increasing.
STEP 4: Draw the graph.
Solved Problem 1
and average total cost (cont’d)
Cost (dollars
per litre) MC
ATC
$1710
1210
51 Quantity (kilolitres per day)
GRAPHING COST CURVES
 Average fixed cost: Fixed cost divided by the quantity of output

produced.
 Average variable cost: Variable cost divided by the quantity of
output produced.
Average total cost = ATC = TC/Q

Average fixed cost = AFC = FC/Q
Average variable cost = AVC = VC/Q
Notice that average total cost (ATC) is just the sum of average fixed
cost (AFC) plus average variable cost (AVC):
ATC = AFC + AVC
GRAPHING COST CURVES (cont’d)
Relationships between MC, ATC, AVC and AFC
1. The MC, ATC and AVC curves are all U-shaped, and the marginal
cost curve intersects the average variable cost and average total
cost curves at their minimum points.
2. As output increases, AFC gets smaller and smaller.
3. As output increases, the difference between average total cost,

and average variable cost decreases.
Costs at Julie Johnson’s photocopying store :
Figure 7.4
COSTS IN THE LONG RUN
Returns to scale
 Long-run average cost curve: A curve showing the lowest cost at

which the firm is able to produce a given quantity of output in the
long run, when no inputs are fixed.
 Economies of scale: Economies of scale exist when a firm’s long-

run average costs fall as it increases its scale of production and the
quantity of output it produces.
COSTS IN THE LONG RUN(cont’d)
Returns to scale (cont’d)
 Constant returns to scale: Exist when a firm’s long-run average

costs remain unchanged as it increases its scale of production and
the quantity of output it produces.
 Minimum efficient scale: The level of output at which all

economies of scale have been exhausted. It is the minimum point on
the long-run average cost curve.
 Diseconomies of scale: Exist when a firm’s long-run average costs

rise as it increases its scale of production and the quantity of output
it produces.
The relationship between short-run average total
cost and long-run average cost: Figure 7.5
The Colossal River Rouge: Diseconomies of scale
at the Ford Motor Company
The following description of the River

Rouge plant comes from the
biography of Ford by Allan Nevins
and Frank Ernest Hill:
A total of 93 separate structures
stood on the [River Rouge] site …
Railroad trackage covered 93 miles,
conveyors 27 [miles]. About 75 000
men worked in the great plant.
The Colossal River Rouge: Diseconomies of scale
at the Ford Motor Company (cont’d)
A force of 5000 did nothing but keep it clean, wearing out

5000 mops and 3000 brooms a month, and using 86 tons
of soap on the floors, walls, and 330 acres of windows.
The Rouge was an industrial city, immense, concentrated,
packed with power … By its very massiveness and
complexity, it denied men at the top contact with and
understanding of those beneath, and gave those beneath a
sense of being lost in inexorable immensity and power.
A summary of definitions of cost: Table 7.4
An inside look
Can economies of scale rescue Tesla?
This article discusses the way in which

the average cost of producing car
batteries for electric cars falls as the
scale of production increases—
economies of scale are very important
for car battery (and car)
manufacturing. The article also
highlights the importance of the price
of car batteries in the costs of
producing electric cars. It points out
that the price of car batteries has
made the cost of producing Tesla cars
Figure 1: Long-run
very high and hence prices for many
average cost of electric
consumers unattractive.
car batteries.
An inside look (cont’d)
Can economies of scale rescue Tesla?
Figure 2: The effect of lower battery costs on the long-run average cost
of electric cars.
Key terms
Average fixed cost Long run average cost curve

Average product of labour Marginal cost
Average total cost Marginal product of labour
Average variable cost Minimum efficient scale
Constant returns to scale Opportunity cost
Diseconomies of scale Production function
Economies of scale Short run
Explicit cost Technological change
Fixed costs Technology
Implicit cost Total cost
Law of diminishing returns Variable costs
Long run

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ECON101: Introductory

Copyright ©2018 Pearson Australia (a division

1. Define technology and give examples of technological change.

2. Distinguish between the economic short run and the economic

3. Understand the relationship between the marginal product of

4. Explain and illustrate the relationship between marginal cost and

5. Graph average total cost, average variable cost, average fixed

6. Understand how firms use the long-run average cost curve in

 Technology: The processes a firm uses to turn inputs into outputs of

 Technological change: A change in the ability of a firm to produce

• Technological change can come from

• The definition of the short and long run

All of a firm’s costs are either fixed or variable, so we can state:

Total Cost = Fixed Cost + Variable Cost

Making the Connection 7.1

 Inventories are an input into Bunnings’ output sold to consumers.

 Opportunity cost: The highest-valued alternative that must be

 Explicit cost: A cost that involves spending money.

 Implicit cost: A non-monetary opportunity cost.

Costs Per Year, $

Making the Connection 7.2

Academic publishers hire editors,

Making the Connection 7.2

A first look at the relationship between production and cost

 Average total cost: Total cost divided by the quantity of output

 Law of diminishing returns: The principle that, at some point,

Average product of labour: The total output produced by a firm

733.3 = (625 + 700 + 875) / 3

Average Marginal Marginal Marginal

Is Julie Johnson right or wrong when she says the following?

Solving the problem:

STEP 1: Review the chapter material. The problem requires

STEP 2: Calculate average total cost and marginal cost. Average

STEP 3: Use the relationship between marginal cost and

STEP 4: Draw the graph.

51 Quantity (kilolitres per day)

 Average fixed cost: Fixed cost divided by the quantity of output

Average total cost = ATC = TC/Q

ATC = AFC + AVC

Relationships between MC, ATC, AVC and AFC

2. As output increases, AFC gets smaller and smaller.

3. As output increases, the difference between average total cost,

 Long-run average cost curve: A curve showing the lowest cost at

 Economies of scale: Economies of scale exist when a firm’s long-

Returns to scale (cont’d)

 Constant returns to scale: Exist when a firm’s long-run average

 Minimum efficient scale: The level of output at which all

 Diseconomies of scale: Exist when a firm’s long-run average costs

The following description of the River

A force of 5000 did nothing but keep it clean, wearing out

Can economies of scale rescue Tesla?

This article discusses the way in which

Can economies of scale rescue Tesla?

Average fixed cost Long run average cost curve

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