CHAPTER 11: OUTPUT AND COSTS
1.The goal of the firm
2.Decision Time Frames
3. Shortrun technology constraint – TP,MP & AP and
shape of these curves
4.Malthus and the Green Revolution
5.Economic cost – Waiting for the Doctor
6. TC,TFC,TVC, MC,AC,AFC & AVC – shape of the
7.Relationship between marginal and average values
8.Shifts in the cost curves
10. LRAC curve as the envelope of SRAC curves
11. Returns to scale
12. Choosing an Ink jet or a Laser printer
1 Chapter 11: Output and Costs
What do General Motors, Hydro One, and Campus Sweaters, have in common?
Like every firm,
They must decide how much to produce.
How many people to employ.
How much and what type of capital equipment to use.
How do firms make these decision ?
1.The goal of the firm:
2. Decision Time Frames
• A firm owner’s decisions can be categorized as short run decisions and
long run decisions.
• The short run is a time frame in which the quantities of some resources are
fixed. The fixed resources include the firm’s management organization
structure, level of technology, buildings and large equipment. These factors
are called the firm’s plant.
• The long run is a time frame in which the quantities of all resources can be
varied. Longrun decisions are not easily reversed so usually a firm must
live with the plant size that it has created for some time. The past costs of
buying a plant that has no resale value is called a sunk cost.
3. ShortRun Technology Constraint
To increase its output in the short run, a firm must increase the quantity of
labour employed. There are three relationships between the quantity of
labour and the firm’s output.
2 Product Schedules Total Marginal Average
Labour product product product
Total product is the maximum output that a 0 0
given quantity of labour can produce. 10
1 10 10
The marginal product of labour is the increase 2 30 15
in total product that results from a oneunit 6
3 36 12
increase in the quantity of labour employed
with all other inputs remaining the same.
The average product of labour is equal to the total product of labour divided
by the quantity of labour. The table to the right has examples of these
• The total product curve illustrates the total product schedule. The slope of
the total product curve equals the marginal product of labour at that quantity
• The marginal product curve shows the additional output generated by each
additional unit of labour. As the figure shows, the marginal product of
labour curve (MP) has an upsidedown U shape.
3 The law of diminishing returns states 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.
• The average product curve shows the average product that is generated by
labour at each level of labour. As the figure shows, the average product of
labour curve (AP) has an upsidedown U shape.
• As the figure shows, the marginal product curve and the average product
curve are related: when the marginal product of labour exceeds the average
product of labour, the average product of labour increases; when the
marginal product of labour is less than the average product of labour, the
average product of labour decreases; and the marginal product of labour
equals the average product of labour when the average product of labour is
at its maximum.
4. Malthus and the Green Revolution
4 5. Economic cost – Waiting for the Doctor
6. ShortRun Cost: TC,TFC,TVC, MC,AC,AFC & AVC –
shape of the cost curves
Fixed cosVariable Total costAverage Average Average Marginal cost
(dollars) cost (dollars) fixed cosvariable total co(dollars)
Labour Output (dollars) (dollars) (dollars) (dollars)
0 0 50 0 50
1 10 50 100 150 5.00 10.00 15.00
2 30 50 200 250 1.66 6.67 8.33
3 36 50 300 350 1.39 8.33 9.72
The table above continues the previous product schedule table and shows
5 Total Cost
• Total cost (TC) is the cost of all the factors of production a firm uses.
• Total fixed cost (TFC) is the cost of the firm’s fixed inputs.
• Total variable cost (TVC) is the cost of the firm’s variable inputs.
• Total cost is the sum of total fixed cost plus total variable cost so
TC = TFC + TVC.
Marginal Cost and Average Costs
•Marginal cost MC ) is the increase in total cost that results from a oneunit
increase in output. The MC curve is Ushaped.
•Average fixed cost AFC ) is total fixed cost per unit of output. The value of
AFC falls as output increases.
•Average variable cost (AVC ) is total variable costs per unit of output. At
low levels of output, AVC falls as output increases but at higher levels of
output, AVC rises as output increases.
• Average total cost (ATC) is the total cost per unit of output. ATC = AFC +
At low levels of output, ATC falls as output increases but at higher levels of
output, ATC rises as output increases.
6 • The next figure illustrates typical MC, AFC, AVC, and ATC curves. As the
figure shows, the MC curve, the AVC curve, and the ATC curve are all U
shaped. There are other additional important points about this figure:
• The vertical distance between the AVC curve and the ATC curve is the AFC.
Because the AFC decreases as output increases, these curves become closer
to each other as output increases.
• The MC curve intersects the AVC curve and ATC curve at their minimums.
• The shape of the cost curves is related t