Lecture: Output and Cost

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2 Apr 2012
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Lecture #16 ECON*1050 Page 1
MICROECONOMICS
Output and Cost
Introduction
- firms must make decisions:
o how much production
o how many employees
o what type and how much capital equipment to use
Decision Time Frames
- profit maximization: main goal of firms
A. Short Run Decisions
- short run: time frame in which the quantity of one or more resources used in
production is fixed
- plant: firm capital
o usually fixed in the short run
o other resources used by the firm (labour, raw materials, energy) can vary
in the short run
- short run decisions are easily reversed
B. Long Run Decisions
- long run: time frame in which the quantities of all resources can be varied
o includes plant size
- not easily reversed
- sunk cost: cost incurred by the firm that cannot be changed
o example: plant no resale value
o irrelevant to current decisions, as no current decision will change this cost
Short Run Technology Constraint
- to increase output in the short run, firm must increase labour employed
- relationship between output and quantity of labour employed:
o total product: total output produced in a given period
labour = TP
o marginal product: change in total product resulting from a one-unit
increase in the quantity of labour employed
all other inputs remain the same
labour = MP initially, but MP eventually
o average product: total product per unit of labour employed
labour = AP initially, but AP eventually
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Lecture #16 ECON*1050 Page 2
© 2010 Pearson Education Canada
The total product curve is
similar to the PPF.
It separates attainable
output levels from
unattainable output levels
in the short run.
Short-Run Technology Constraint
© 2010 Pearson Education Canada
To make a graph of the
marginal product of
labour, we can stack the
bars in the previous
graph side by side.
The marginal product of
labour curve passes
through the mid-points of
these bars.
Short-Run Technology Constraint
© 2010 Pearson Education Canada
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 Technology Constraint
Product Curves
A. Total Product Curve
- similar to the PPF; separates attainable output levels from unattainable output
levels in the short run
- increases at a decreasing rate due to diminishing marginal product
B. Marginal Product Curve
- rise in TP over a one-unit increase of labour is the marginal product of labour
- increasing marginal returns: MP of a worker exceeds MP of the previous
worker; MP of labour
o arise from specialization and division of labour
- decreasing marginal returns: MP of a worker is less than MP of the previous
worker; MP of labour
o arise from the fact that with each additional unit of labour, each worker
has less access to capital and less space in which to work
o law of diminishing returns: as a firm uses more of a variable input with a
given quantity of fixed inputs, the marginal product of he variable input
eventually diminishes
C. Average Product Curve
- when MP exceeds average productivity, average product
- when MP is below average productivity, average product
- when MP = average productivity, AP is maximized
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Lecture #16 ECON*1050 Page 3
Short Run Cost
- to output in the short run, firm must employ more labour
o firm must costs
- costs change as total productivity changes, and three cost concepts exist:
A. Total Cost
- total cost (TC): cost of all resources used; increases with output
o TC = TFC + TVC
o curve parallel to the TVC curve, shifted upwards by a vertical distance of
TFC
- total fixed cost (TFC): cost of fixed inputs; constant as output changes
o example: buildings and machinery
o straight horizontal line graph
- total variable cost (TVC): cost of firm’s variable inputs; changes with output
o steeper at high output levels than at low ouput levels
o opposite of total productivity curve (axes are switched)
© 2010 Pearson Education Canada
Figure11.4showsafirm’s
total cost curves.
Total fixed cost 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.
Short-Run Cost
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