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Chapter 11.docx

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ECON 1010
Pascal Ghazalian

Chapter 11 Output and Costs Decision Time Frames The firm makes many decisions to achieve its main objective: profit maximization Some decisions are critical to the survival of the firm Some decisions are irreversible (or very costly to reverse) Other decisions are easily reversed and are less critical to the survival of the firm, but still influence profit All decisions can be placed in two time frames o The short run o The long run The Short Run  The short run is a time frame in which the quantity of one or more resources used in production is fixed.  For most firms, the capital, called the firm’s plant, is fixed in the short run  Other resources used by the firm (such as labor, raw materials and energy) can be changed in the short run  Short-run decisions are easily reversed The Long Run  The long run is a time frame in which the quantities of all resources-including plant size- can be varied  Long-run decisions are not easily reversed  A sunk cost is a cost incurred by the firm and cannot be changed  If a firm’s plant has no resale value, the amount paid for it is a sunk cost  Sunk costs are irrelevant to a firm’s current decisions Short-Run Technology Constraint  To increase output in the short run, a firm must increase the amount of labor employed  Three concepts describe the relationship between output and the quantity of labor employed:  Total product  Marginal product  Average product Product schedules  Total product is the total output produced in given period  The marginal product of labor is the change in total product that results from one-unit increase in the quantity of labor employed, with all other inputs remaining the same  The average product of labor is equal to total product divided by the quantity of labor employed Short Run technology constraint  As the quantity of labor employed increases:  Total product increases  Marginal product increases initially but eventually decreases  Average product increases initially but eventually decreases  Product curves show how the firms total product, marginal product and average product change as the firm varies the quantity of labor employed  Total product curve shows how changes with the quantity of labor employed  Similar to the PPF, it separates attainable output levels from unattainable output levels in the short run  Marginal product curve Shows the marginal product of labor curve and how the marginal product curve relates to the total product curve  The first worker produces 4 unties of output  The second worker hired produces 6 units of putout and total product output becomes 10 units  The third worker hired produces 3 units of output and total product output becomes 13 units  The height of each bar measures the marginal product of labor  For example, when labor increases form 2 to 3, total product increases from 10 to 13  The marginal product of the third worker is 3 units of output  To make a graph of marginal product of labor, we can stack the bars in the previous graph side by side  The Marginal product of labor curve passes through he midpoints of these bars.  Almost all of production processes are like the one shown here and have:  Increasing marginal returns initially  Diminishing marginal returns eventually  Increasing Marginal Returns  Initially the marginal product of a worker exceeds the marginal product of the previous worker  The firm experiences increasing marginal returns  Diminishing Marginal Returns  Eventually, the marginal produce t of a worker is less than the marginal product of the previous worker  The firm experiences diminishing marginal returns  Increasing marginal returns arise from increased specialization and division of labor  Diminishing marginal returns arises because each additional worker has less access to capital and less space in which to work  Diminishing marginal returns are so pervasive that they are elevated to the status of a “law”  The law of diminishing return stats that 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  Average product curve shows the average product curve and its relationship with the marginal product curve  When marginal product, exceeds average product, average product increases  When marginal product is below average product, average product decreases  When marginal product equals average product, average product is at its maximum Short Run Cost  To produce more output in the short run, the firm must employ more labor, which means that it must increase its costs  Three cost concepts and three types of cost curves are o Total cost o Marginal cost o Average cost  Total cost (TC) is the cost of all resources used  Total fixed cost (TFC) is the cost of the firm’s fixed inputs. Fixed costs do not change with output  Total variable cost (TVC) is the cost of the firm’s variable inputs. Variable costs do change with output  TC= TFC + TVC  Total fixed costs is the same at each output level  Total variable cost increases as output increases  Total cost, which is the sum of TFC and TVC also increases as output increases  The AVC curve gets its shape from the TP curve  Notice that the TP curve becomes steeper tat low output levels and then less steep at high output levels  In contrast, the TVC curve becomes less steep at low output levels and steeper at high output levels  Marginal cost is the increase in total cost that results from a one0unit increase in total product  Over the output range with increasing marginal returns, marginal cost falls as output increases  Over the output range with diminishing marginal retur
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