ECON 103 Lecture Notes - Diminishing Returns, Average Cost, Sunk Costs

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19 Apr 2013
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Fraser International College
ECON1034 “Principles of Microeconomics”
Chapter 11: Output and Costs
THE KEY CONCEPTS in this chapter:
-The short run and short-run decisions
-Short-run product and cost; curves; shifts of curves
-The long run and long-run decisions
-Long –run cost; curves
-Production function
-Economies and diseconomies of scale
A firm makes decisions in the short run and long run. The firm’s costs and output depend on this
time horizon.
The short run is a time period in which the quantity of at least one input is fixed and cannot
be changed by a firm’s decision.
Usually, the inputs that are fixed in the short run are physical capital, land, and entrepreneurship.
So, in the short run, a firm makes decision only about labor: how many workers to hire.
If a firm wants to produce more in the short run, it has to hire more workers who will work on
the existence equipment.
Short Run Decisions are easily reversed.
The long run is a time period in which the quantity of any input and of all inputs can be changed
by a firm’s decision.
So, in the long run a firm makes decisions about how much equipment to have, how many
materials to buy, how many workers to hire, how to organize management.
If a firm wants to produce more in the long run, it could build additional factories, buy more
land, hire more workers, change management.
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Long run decisions determine what a firm could do in the short run, because long-run decision
are often not reversible: once a factory was equipped with certain type of machines, it could be
difficult to change these machines into a different type.
Past expenditures on firm’s inputs that cannot be resold are sometimes called sunk costs
Sunk Cost is the cost which is not recoverable.
Short-run product and costs
In the short run, firm’s output and costs depend on the labor input.
Output and labor are related through the co-called “product” of labor.
There are:
1. Total product of labor
2. Marginal product of labor
3. Average product of labor
Total product of labor
This is the maximum quantity of output that a given number of workers can produce in a given
unit of time (for example, per day).
As the number of workers increases, total product increases.
Points on the curve are Efficient.
Marginal product of labor
This is measured by how many units of output are added to the total product by each additional
worker.
At first, each additional worker contributes more than the previous one. This is called
increasing marginal returns.
But as more workers are added, each additional worker contributes less than the previous one.
This is called diminishing marginal returns.
At start value increases but after reaching maximum it decreases.
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Average product of labor
This is the total product divided by the number of workers. This ratio tells us how productive
workers on average.
It keep on decreasing as the worker increases.
Average product and marginal product are related in a specific way.
Labor
(number
of workers)
Total product
(units of output
per day)
Marginal product
(units of output per
Average product
(units of output per
worker)
A 0 0
B 1 4
C 2 10
D 3 13
E 4 15
F 5 16
Product curves
We could represent the costs as curves, on a diagram.
1. Total product of labor
Marginal product of labor
Average product of labor
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