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Econ 1B03 - Chapter 13 Part 2.docx

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Hannah Holmes

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Econ 1B03 – Chapter 13  We often refer to diminishing MP (Marginal Product) as diminishing returns to an input  In our example, we have diminishing returns to labour  Now let’s graph Jerry’s production function: o  Maximum of the function occurs when the tangent is 0 (50, 180)  Whenever marginal product is 0 you are maximizing total product(TP)  Notice that TP is maximized when the slope of the TP function is 0.  Since the slope of the TP function is MP  TP is maximized when MP = 0  Also related to production is the concept of Average Product, AP = Q/# of inputs  AP tells us the quantity of output per input, in our case, Jerry’s labour.  AP will also diminish at some point  Let’s calculate it: o o o MP = AP at maximum AP  Things to note: o TP is maximized when L = 50 o This means that MP = 0 when L = 50 o AP intersects MP at max AP  Most MP and AP curves are nice and smooth: o  Whenever MP is higher than AP, AP is necessarily increasing.  Whenever MP is less than AP, AP is decreasing  Also note, Jerry wouldn’t hire after the 50 worker because they lower his output  A firm goes from 4 to 5 workers. MP goes from 9 to 7; average production goes from 6 to 7. o AP is at a maximum. When AP = MP, AP is at maximum. TP is maximized when MP = 0. We don’t know where MP was maximized. Not enough info. Cost of Production  Of course, Jerry is concerned about his costs of production.  Costs of production may be divided into fixed costs and variable costs.  Fixed Costs: Costs are that do not vary with a change in output level. E.g. rent, loan payments  Variable costs: Costs that do vary with changes in output levels. E.g. labour costs, raw materials costs  Costs also depend on the time horizon 
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